What is CFD trading and how does it work?

What is a contract for difference (CFD)?

A contract for difference (CFD) is a derivative product, meaning that it derives its price from an underlying asset. It allows you to trade on the price movements of financial markets without buying the asset itself. You enter an agreement with your provider to exchange the difference in the asset's price from the time you open to the time you close the position.

You can trade CFDs on a wide range of markets, including:

• Shares
• Indices
• Commodities
• Forex
• Cryptocurrencies

Because CFDs are derivatives, you don't take ownership of the asset. Instead, you're speculating on whether the price will rise or fall.

How does CFD trading work?

When you trade CFDs, you choose whether to go:

• Long (buy): if you think the market will rise
• Short (sell): if you think the market will fall

You’ll see two prices when you go to trade. The buy price is where you’ll open a long position, and close a short position. The sell price is where you’ll open a short position, and close a long one.

The difference between the two is called the spread, and is the main cost your trade will incur. More on that later.

Your profit or loss moves in line with the market price. The more the market moves in your favour, the more you gain. If it moves against you, you’ll make a loss.

CFD positions are typically opened and closed within short timeframes, but you can also hold them longer – though holding overnight may incur additional fees.

What is a CFD account?

A CFD account is what you open with a broker in order to trade CFDs. It gives you access to a platform where you can monitor markets, place trades, view charts and manage your account.

Most providers also offer a demo account, which lets you practise trading with virtual funds before risking real money. This is a good way to get familiar with the platform and understand how CFD trading works.

In many regions, you’ll need to pass an appropriateness check before opening a live account. This may involve answering a few questions to show you understand the risks involved in leveraged trading. It’s important to know how margin works and be aware of how quickly losses can occur.

What is leverage in CFD trading?

CFDs are traded on margin, which means you only need to deposit a portion of the total trade value to open a position. This is known as leveraged trading.

Leverage can amplify both profits and losses. For example, a 20% margin (giving you 20:1 leverage) means you need to deposit $200 to open a $1,000 trade. But if the market moves against you, losses are calculated on the full $1,000.

Types of margin

Deposit margin is the initial amount required to open a position. It’s based on the size of the trade and the margin rate set by the regulator.

Maintenance margin is the amount of equity you must hold in your account to keep trades open. If your account falls below this level, you may receive a margin call (more on that later).

Margin requirements can vary by asset class and market conditions. Make sure you understand the specific margin levels before placing a trade.

What does CFD trading cost?

When you trade CFDs, there are a few key costs to be aware of.

• Spread: the difference between the buy (ask) and sell (bid) price. You buy at the higher price and sell at the lower. The market must move in your favour beyond the spread for your position to be profitable.
• Overnight funding adjustments: hold your position overnight, and you’ll usually be charged a fee. This reflects the cost of keeping your trade open with borrowed funds, ie margin.
• Guaranteed stop-loss fees (optional): set a guaranteed stop to close your position at your chosen level and limit further potential losses, and you may be charged a fee if it triggers.

This isn’t an exhaustive list – different providers may charge for different services.

Capital.com does not charge commission on trades, deposits or withdrawals. However, other providers may have different fee structures. Always check before opening an account.

What assets can you trade with CFDs?

CFDs offer access to thousands of markets, including:

• Global shares like Apple, Tesla and HSBC
• Stock indices such as the S&P 500 or FTSE 100
• Commodities like gold, oil and silver
• Major and minor forex pairs: EUR/USD, USD/JPY and more
• Cryptocurrencies including bitcoin and ether

This wide range is a key reason many traders choose CFDs: they enable you to diversify your portfolio from a single account.

Example CFD trade

Let’s compare opening a long CFD trade on a stock vs buying that stock outright.

Scenario 1: profit

Say the price goes up 10 points. You’re happy with the profit, and you go to close your trade.

Your profit on both trades is the same. But you’ve made a 37% profit on your CFD trade, and a 7% profit on your share trade.

Scenario 2: loss

Now imagine the price goes down 10 points, and you close your position to limit your loss.

Again, your loss on both trades is the same. But it’s a roughly 37% loss on your CFD trade, and just a 7% loss on the share trade.

Scenario 3: you lose more than you deposited

Say the stock goes down 30 points.

You’ve made over 100% loss on your CFD trade, but a 20% loss on your share trade.

On your CFD trade, it’s likely that your provider would have started closing your position before things got this far. Many regulators also stipulate that CFD brokers must provide negative balance protection, which stops your account balance ever going below zero.

However, your individual positions can still end up eating into your balance if markets move against you. So it’s important to have a sound risk management strategy.

CFD risk management tools

Luckily, you have plenty of tools at your disposal to manage your risk when you’re trading CFDs.

Stop-losses

A stop-loss is an order to your broker to execute a trade on your behalf, at a less favourable level than the current market price.

You’d set a stop-loss order to automatically close your position at a certain price, if the market moves against you. This helps limit your losses without needing to constantly watch the market.

Guaranteed stop-losses

You can protect your position even further with a guaranteed stop-loss (GSL). This works the same as a stop-loss, but guarantees that your order will be executed at exactly the price you specify.

If your GSL is triggered, you’ll pay a fee for that guarantee – but you’ll have peace of mind that you’re protected against slippage.

Trailing stops

A trailing stop is a stop-loss that moves with the market when it’s going in your favour, locking in potential gains. If the market turns, the stop stays fixed and closes your position to limit losses. Trailing stops aren’t guaranteed, though, so can be subject to slippage.

Take-profits

A take-profit is an order to execute a trade at a more favourable level than the current market price.

You can set a take-profit level to automatically close your position when your target profit is hit. This can help you lock in gains and avoid emotional decision-making during live market conditions.

Margin call and negative balance protection

Your CFD provider will also have processes that protect you against risk. You shouldn’t rely on these as part of your risk management strategy, but it’s helpful to be aware of them regardless.

Margin calls and gradual close-out

If your equity (ie the value of your account) drops below 100% of your maintenance margin, you may receive a margin call asking you to top up your balance or reduce your exposure. If you don’t act, your provider may gradually close your positions to reduce risk.

At Capital.com, you’ll get a second margin call when your equity reaches 75% of your margin requirements. When it reaches 50%, we start to close positions automatically to prevent you losing any more.

That said, you shouldn’t rely on margin calls as a risk management tool.

Negative balance protection

Many regulators stipulate that your provider must offer negative balance protection to retail (ie non-professional). This means that your account balance can’t go below zero.

However, that doesn’t mean that you can’t lose more than your initial margin on a single trade.

Professional clients – sometimes referred to as wholesale clients – don’t get this protection.

The benefits of CFD trading

CFDs offer flexibility and access to a wide range of financial markets, making them a popular choice for active traders. If you understand the risks and use the right tools, they can provide several advantages over traditional investing.

Trade rising and falling markets

With CFDs, you can go long (buy) if you think a market will rise — or go short (sell) if you expect it to fall. This gives you the opportunity to trade in both directions and react to changing market conditions.

Pay less to open a position

CFDs are traded on margin, so you only need to deposit a portion of the full trade value. This allows you to open larger positions than you could with a direct investment – though it also increases your potential losses.

Get thousands of markets from one account

CFDs offer exposure to a wide range of asset classes, from shares, indices and commodities to forex and crypto. That means you can diversify your strategy across different sectors and regions, all from one platform.

Hedge your existing investments

You can use CFDs to offset potential losses in your long-term portfolio. For example, say you hold shares, but expect a short-term dip. You don’t want to sell, so take a short CFD position on the stock. If prices fall, gains from your CFD trade may help balance out losses elsewhere.

The risks of CFD trading

CFD trading is risky, and isn’t suitable for everyone. Before you open a position, it’s important to understand how quickly losses can occur – especially when trading with leverage.

You can lose money quickly

Leverage means you only put down a fraction of the total trade value, but your profits and losses are calculated on the full amount. That means even small market moves can result in large losses, including losing your entire deposit on a single trade.

Markets can move unexpectedly

In volatile conditions, markets can ‘gap’ – moving suddenly from one price to another with no trading in between. If this happens, your stop-loss may not execute at the level you set, resulting in a larger-than-expected loss. This is known as slippage. A guaranteed stop-loss (GSL) can protect you against this, but it comes at a cost.

Positions can be closed without warning

If your account equity falls below the required margin, your provider may begin to close your positions to protect you from further loss. This is called a margin close-out. You might not receive advance notice in fast-moving markets.

Not understanding the product

CFDs are complex. If you’re unsure how they work – especially in relation to margin, leverage, or risk – it’s easy to make costly mistakes. A demo account can be a useful place to start before trading with real money.

This list of risks isn’t exhaustive. It’s important to do plenty of research before you trade. Learn more about CFD trading with our free educational resources.