What Is a CFD? How Contracts for Difference Work

Start with what happens on the screen, because the mechanics explain the definition better than the definition explains the mechanics.

You think an index is going to fall. You open a sell position on it at 5,000. Two days later it trades at 4,960 and you close. Nothing was borrowed, nothing was sold, and you never held anything. The broker pays you the difference between 5,000 and 4,960, multiplied by your position size, minus the costs of holding it.

That is a contract for difference. The whole product is in that paragraph.

What CFD stands for, and what the contract is

CFD stands for contract for difference. It is an agreement between you and your broker to exchange the difference in an instrument's price between the moment the position opens and the moment it closes.

The instrument is a reference point. When you trade a gold CFD, no gold moves. When you trade a share CFD, no share changes hands and no share register is updated. The price of the real asset determines the settlement, and that is the extent of the connection.

Three things follow from this, and they define the whole product:

1. You do not own anything. No share certificate, no voting rights, no metal in a vault. Your position is a claim against your broker, settled in cash.

2. You can open in either direction. Selling first and buying back later is as ordinary as the reverse, because there is no asset to locate or borrow. A sell position gains value when the price falls.

3. The position is leveraged. You post a fraction of the position's face value as margin. The profit and loss are calculated on the full value, not on what you posted.

How a trade opens and closes

The quote. Every instrument shows two prices. The bid is where you can sell. The ask is where you can buy. The gap between them is the spread.

Opening. You choose a direction and a size. Buy at the ask, sell at the bid. The platform sets aside margin from your balance. The position is now open and its value changes with every tick.

While it is open. Your unrealised profit or loss moves in real time. It is not yours until you close. If the position moves far enough against you, your margin level falls and the broker can close positions automatically to protect the account.

Closing. You exit at the opposite side of the quote from where you entered. The difference between entry and exit, multiplied by your position size, is your realised result. Margin is released back to your balance.

Because you cross the spread on the way in, a position starts fractionally negative. The price has to move in your favour by the width of the spread before you are level.

The costs

Three costs, and they work differently from each other.

• The spread. Built into the quote. If a pair shows 1.08495 / 1.08505, that one-pip gap is what you pay to open. Spreads widen when liquidity thins, particularly around economic releases and at session changeovers.

• Overnight funding. Also called swap. Because the position is leveraged, holding it past the daily cutoff attracts a financing charge or credit, applied each night. It reflects the interest rate differential between the two sides of the trade plus the broker's markup. On some positions it is a credit rather than a debit. It compounds quietly, and it is the cost that most surprises people who hold positions for weeks.

• Commission. Account-dependent. Some accounts fold the entire cost into a wider spread and charge nothing separately. Others quote a raw spread and charge a fixed amount per lot. Neither is automatically cheaper; the answer depends on how much you trade.

• Margin sits apart from these three. It is a portion of your own balance held while the position is open, and it returns to your balance when you close.

Worked example: a long position

You buy 10,000 units of EUR/USD. The quote is 1.08495 / 1.08505, so you enter at the ask of 1.08505.

• Position value: 10,000 × 1.08505 = US$10,850

• Margin posted: a fraction of that, set by your leverage cap

• Value of one pip on 10,000 units: US$1

If the price rises. The quote moves to 1.08695 / 1.08705. You close by selling at the bid of 1.08695.

• 1.08695 − 1.08505 = 0.00190, which is 19 pips

• 19 × US$1 = US$19

• Held three nights at, say, US$0.45 per night = −US$1.35

• Result: US$17.65

Note that the market moved 20 pips but you captured 19. The missing pip is the spread.

If the price falls. The quote moves to 1.08295 / 1.08305 and you close at 1.08295.

• 1.08295 − 1.08505 = −0.00210, which is 21 pips against you

• 21 × US$1 = −US$21

• Plus the same three nights of funding = −US$22.35

Same instrument, same size, same holding period. The spread costs you a pip in both directions, and the funding is charged whether the trade worked or not.

Worked example: a short position

An index trades at 5,000. You sell 10 contracts at A$1 per point.

• Position value: 10 × 5,000 × A$1 = A$50,000

• Margin posted: a fraction of that

• Value of one point: A$10

If the index falls. It reaches 4,960 and you close.

• 5,000 − 4,960 = 40 points in your favour

• 40 × A$10 = A$400

• Less the spread, roughly 2 points, so −A$20

• Less overnight funding for the nights held

• Result: approximately A$380

If the index rises. It reaches 5,040 and you close.

• 5,000 − 5,040 = 40 points against you

• 40 × A$10 = −A$400

• Less the spread, −A$20

• Less overnight funding

• Result: approximately −A$420

The arithmetic is symmetrical. What is not symmetrical is the cost, which subtracts from a gain and adds to a loss.

Leverage, and the part that matters most

In both examples above, the loss column is calculated on the full position value, not on the margin you posted. That is the entire risk of the product in one sentence.

If you posted A$2,500 of margin against a A$50,000 index position, a 5% adverse move produces a A$2,500 loss. Your margin is gone on a move the underlying market would consider routine.

Losses can exceed the margin you committed to a position, and can consume your whole account balance. A leveraged position does not stop losing when your margin is used up.

Two mechanisms limit this, and you need to know which apply to you.

A stop-loss order closes the position at a level you set. Standard stops are not guaranteed. In a fast market or across a weekend gap, the position can close beyond your level.

Negative balance protection, where it applies, prevents your account from going below zero. It is mandatory for retail clients in some jurisdictions, including Australia, and offered voluntarily by some brokers elsewhere. Confirm whether it applies to your account rather than assuming it does.

Retail leverage is capped in many jurisdictions, with a lower cap on more volatile instruments. The caps that apply to you depend on where you live and what you are trading.

Most retail CFD accounts lose money. Brokers in a number of jurisdictions are required to publish their own figure, and it is worth reading before you open an account anywhere.

Common questions

What does CFD stand for?

Contract for difference. The name describes the product accurately: it is a contract to exchange the difference in an instrument's price between opening and closing, settled in cash.

Do I own the underlying asset?

No. Whatever the instrument is, you hold a cash-settled contract with your broker and nothing else. There is no share register entry, no metal in a vault and no currency in a bank account.

The practical consequence is that your counterparty is the broker. If a position is profitable, you are relying on that broker to settle it. This is why how the firm is regulated and whether client funds are held separately from company funds are not administrative details.

Can I lose more than my deposit?

Losses are calculated on the full position value, not on the margin you posted, so a loss can be far larger than the margin held against that trade and can consume your entire account balance.

Whether the account itself can go negative depends on negative balance protection. It is a regulatory requirement for retail clients in a number of jurisdictions, Australia among them, and some brokers offer it voluntarily elsewhere. Where it applies, your loss is capped at your balance. Where it does not, a sufficiently violent gap can leave you owing money.

Establish which applies to your account before you fund it.

Can I hold a CFD for months?

You can, but the structure works against it.

Overnight funding is charged or credited every night the position is open. On a long position in most conditions it is a debit, and it accrues regardless of whether the trade is working. Over months, that accumulation can become a significant part of the outcome on its own.

CFDs are built for shorter horizons. Longer holding periods are usually served better by instruments without a nightly financing charge.

Why does my overnight funding change from night to night?

Because it is derived from interest rates, which move, and from the broker's markup, which is fixed but applies to a changing base.

Two other things cause surprises. Positions held over the weekend are usually charged three days of funding on a single midweek night, since the market is closed but interest still accrues. And on some pairs, holding one direction produces a credit rather than a debit, which reverses if the underlying rate differential does.

Check the swap rates on the specific instrument rather than assuming a general rule.

Why did my position open showing a small loss?

Because you crossed the spread.

You buy at the ask and close at the bid, or the reverse for a short. The gap between those two prices is charged at the moment of opening, so the position starts underwater by the width of the spread. The market has to move in your favour by that amount before you are level.

This is normal rather than an execution error. The cost is simply applied at the moment of opening rather than at the end.

What is the difference between the spread widening and slippage?

They are separate things that both cost you money around volatile moments.

Spread widening is the quote itself getting wider. Liquidity providers pull their prices around scheduled releases and at session changeovers, so fewer quotes are available and the gap between bid and ask grows. It affects the price at which any new order can be filled.

Slippage is the difference between the price you expected and the price you actually received. It happens when the market moves between your order being sent and being executed, which is most likely in exactly the same fast conditions.

Both are more common around economic data, at market opens, and in thin overnight liquidity.

What is a margin call, and what is a stop-out?

A margin call is a warning that your account no longer holds comfortable margin for the positions open in it. The broker notifies you and you can add funds or reduce exposure.

A stop-out is not a warning. When your margin level falls below the broker's threshold, the platform closes positions automatically to prevent further loss. You are not consulted, and in a fast market you may be stopped out before you have read the margin call.

The threshold levels are set by the broker and stated in the account terms.

What happens to a CFD position over the weekend?

It stays open, and this is where the largest single risk sits for anyone holding through Friday.

Markets close and reopen at a new price. If news breaks while trading is halted, the reopening price can be far from the closing one, with no trading in between. A standard stop-loss cannot help you inside a gap, because there was no price at your level for it to trigger against. Your position closes at the first available price on the other side.

Weekend funding is also usually charged at three days' worth on one midweek night.

Do CFDs expire?

Most do not. A CFD on a spot instrument such as a currency pair can stay open indefinitely, subject to margin and nightly funding.

There are exceptions. CFDs based on futures contracts, which is common for some commodities and indices, inherit an expiry from the underlying contract. Brokers either close the position at expiry or roll it into the next contract, usually with a cash adjustment. Check the instrument specification, because the behaviour is not uniform.

What happens to dividends on a share CFD?

The broker typically applies a cash adjustment to reflect the dividend on the ex-dividend date, as a credit on a long position and a debit on a short one.

You do not receive an actual dividend, and you have no shareholder rights: no vote, no company communications, no entitlement in a corporate action beyond whatever adjustment the broker applies. Corporate actions such as splits or rights issues are handled by adjusting the position, and the method varies by broker.

What is the smallest position I can open?

Smaller than a standard lot in almost every case. Brokers offer fractional sizes, commonly down to a hundredth of a lot on forex, which allows positions small enough that a normal market move produces a very small monetary result.

The exact minimum varies by broker and by instrument, and it is worth checking before you open an account if you intend to start small deliberately.

Can I trade CFDs without leverage?

Not literally, since margin is built into how the product works, but you can reduce the effective leverage as far as you want.

If you hold a balance well above the margin required and keep positions small relative to that balance, the leverage applied to your account as a whole becomes low even though each position is technically margined. The maximum leverage a broker offers is a ceiling, not an instruction.

Are CFDs the same as futures or options?

No. All three are leveraged derivatives, but they are structurally different.

Futures are standardised exchange-traded contracts with fixed sizes and expiry dates, cleared centrally. Options give the buyer a right rather than an obligation, and are priced on volatility and time as well as the underlying. CFDs are over-the-counter contracts with your broker, with no exchange, no standardised size and usually no expiry.

The pricing, the counterparty and the regulatory treatment all differ.

Are CFDs available in every country?

No. They are prohibited for retail clients in some jurisdictions and restricted in others, with limits on leverage, marketing and bonuses varying considerably between regulators.

Availability depends on where you are resident, not where the broker is based.

What does it mean when a broker publishes a percentage of losing accounts?

Regulators in several jurisdictions require firms to state the proportion of their retail client accounts that lose money when trading CFDs, and to display it prominently.

The figures are typically high across the industry. Read the number wherever it appears before opening an account, and treat any marketing that avoids mentioning it as a signal in itself.

Risk warning: CFDs are leveraged products and carry a high level of risk. Losses can exceed the margin committed to a position and can consume your entire account balance. CFDs are not suitable for all investors. Make sure you understand how these products work and whether you can afford the risk of losing your money. This article is educational information only. It is not investment advice, a recommendation, or an offer to trade, and it does not take account of your objectives, financial situation or needs.

Share this post:

Copy Link