A Contract for Difference (CFD) is a type of financial derivative. It is essentially a wager between two parties facilitated by a CFD platform, where the platform matches buyers and sellers with opposing market views. For example, if you believe the price of gold will rise, you can buy a gold CFD. The CFD platform will then match you with a seller who is bearish on gold. If the price increases, you profit from the other party. If it falls, your money goes to them. A CFD is a zero-sum game between two market participants, and the platform’s role is primarily to facilitate this match.
Since CFDs are contracts between two parties speculating on price movements of an underlying asset, there’s no need to actually own the asset. That means, when speculating on gold using CFDs, you don’t physically buy gold—profits and losses are settled in cash based on the price movement at contract termination.
CFDs are highly flexible instruments. They are especially popular among short-term traders as they allow for both long and short positions and can be traded using leverage—enabling traders to potentially earn significant profits from small price movements.
What Assets Can Be Traded via CFDs?
As CFDs don’t involve physical ownership, a wide range of assets can be traded:
2.1 Stock CFDs
A major advantage of stock CFDs is the ease of going long or short on a company’s stock—something that is relatively difficult with traditional stock trading, particularly for domestic investors. U.S. stock CFDs and Hong Kong stock CFDs are especially popular. Note: since you don’t own the actual shares, you won’t receive dividends.
2.2 Forex CFDs
The foreign exchange market is one of the world’s largest financial markets. Traders can participate via forex CFDs, trading currency pairs like EUR/USD or GBP/JPY. These trades are highly liquid and allow traders to profit from market volatility. Leverage is commonly used in forex CFD trading, amplifying both potential returns and risks.
2.3 Cryptocurrency CFDs
You might have heard of “crypto contracts” often associated with stories of overnight riches or massive losses. These refer to cryptocurrency CFDs. Given the extreme volatility of crypto prices and the high leverage offered by some platforms, returns can be dramatic. There are even success stories of turning a few hundred dollars into hundreds of thousands—primarily due to the high leverage available with CFDs.
CFD Leverage
Leverage is a core feature of CFD trading. It allows traders to control large positions with relatively little capital. While it can magnify profits from small market moves, it also increases the risk of loss, potentially wiping out your initial margin.
Leverage levels vary by platform and asset class. For instance:
- Forex CFDs: High leverage, typically 30:1 or even up to 100:1.
- Stock CFDs: Lower leverage, usually 5:1 to 20:1.
- Cryptocurrency CFDs: Even lower leverage, typically 2:1 to 5:1 due to high market volatility.
Regulations also impact leverage. In the EU, the European Securities and Markets Authority (ESMA) has capped leverage for retail traders—30:1 for forex CFDs and 2:1 for crypto CFDs—to protect them from excessive risk.
CFD Trading Fees
Many mistakenly believe the platform is your counterparty in a CFD trade—it isn’t. The platform acts more like a matchmaking service, similar to how Tencent pairs players in League of Legends; it doesn’t play against you.
For an explanation of how trade matching engines work, you can check out: A Complete Guide to Matching Engines.
Most platforms earn revenue through spreads and overnight financing fees.
Spread
The spread is the difference between the buy (ask) and sell (bid) prices. Platforms set a slightly higher buy price and a slightly lower sell price compared to the market. This difference is measured in pips.
Example:
If EUR/USD is trading at 1.1000, the platform might offer:
- Ask: 1.1002
- Bid: 1.0998
That’s a 4-pip spread.
If you buy 1 standard lot (100,000 units):
- Cost at ask: $110,020
- Immediate sell at bid: $109,980
- Spread cost: $40, deducted from your account upon opening the position.
Spreads vary by asset class. Forex spreads are usually lower due to high liquidity, while spreads for stocks and crypto may be higher.
Overnight Fees
Also known as rollover or swap fees, these are charges for holding positions overnight. Since CFDs use leverage (borrowed funds), you pay interest on the borrowed amount.
Example calculation:
- Position: Long 1 standard lot EUR/USD
- Exchange rate: 1.1000
- Leverage: 30:1
- Overnight rate: -0.01%
Nominal value: $110,000
Margin used: $110,000 / 30 = $3,666.67
Overnight fee: $110,000 * -0.01% = – $11/day
Fees are charged daily at market close, continuing until the position is closed.
Is a CFD the Same as an Option?
While both are derivatives, CFDs and options serve different purposes and have different mechanisms. Options are far more complex.
Buying an option gives you the right (but not the obligation) to buy or sell an asset at a specific price in the future. For example, you might purchase a call option to buy 10,000 Tencent shares at HKD 120 each one year from now. If the market price at expiry is HKD 180, you can exercise the option and buy at 120. If the price is only HKD 90, you can let the option expire and only lose the premium you paid.
Options are often used for hedging, serving as a risk management tool. CFDs, by contrast, are more aggressive and cater to traders willing to take on higher risk for potentially quicker returns.
Are CFDs Legal?
CFD trading is not legal in every country. For example, it’s not permitted in mainland China. Most CFD platforms are registered in jurisdictions where CFD trading is legal.
- Europe: Legal and regulated by ESMA. Strict rules on leverage, advertising, and investor protection.
- Australia: Legal under regulation by ASIC (Australian Securities and Investments Commission). Known for relatively high leverage and strong regulatory framework.
- United States: Illegal for retail clients. The Commodity Futures Trading Commission (CFTC) prohibits CFD trading for U.S. residents.
