What are CFDs and how do they work?

If you’ve ever wondered why some people talk about “buying” oil without owning a single barrel, or “shorting” a stock they never touched, you’ve already brushed up against the strange but very real world of Contract for Difference (CFD).

 

At its core, a CFD is a way to speculate on price movements and charts without owning the underlying asset. They’re flexible, fast, and occasionally unforgiving. So what exactly are they, and how do they work?

 

How CFDs work: A direct agreement with your broker

A CFD is an agreement between you and a broker to exchange the difference in the price of an asset from the time you open a position to the time you close it. This is called net settlement.

 

No ownership, no storage, no delivery. If you open a CFD on gold, you’re not getting the actual gold bar, just exposure to the price movement.

 

This structure allows CFDs to mirror thousands of markets through a simple derivative: stocks, indices, commodities, forex pairs, and even more exotic instruments.

 

This structure also makes CFDs flexible and easy to execute.

 

A long position means you buy the CFD because you expect the price to rise.

 

A short position means you sell the CFD because you expect the price to fall.

 

Profit or loss is calculated by taking the difference between the opening and closing price and multiplying it by the number of contracts. The key risk comes from how the position is financed.

 

Going long, going short, and pretending you own nothing

One of the biggest attractions of CFDs is the freedom to speculate on price moves in either direction. If you think something will rise, you go long (buy). If you think it’ll fall, you go short (sell).

 

The CFD simply tracks the price and pays out (or charges you) the difference.

 

For example, you buy a CFD on a stock at $100. It rises to $105. You close the position and pocket the $5 difference (minus costs).

 

Or you sell at $100 expecting a drop. It slides to $94. You close the position and earn the $6 difference.

 

There’s no talk of dividends, shareholder perks, or storing barrels of oil. You’re trading the movement, not the asset.

 

Leverage: The feature everyone loves until they don’t

Here’s where CFDs get interesting to say the least. They use leverage, meaning you only need to put down a small percentage of the total trade value, known as initial margin, to open a position. The rest is effectively borrowed from the broker.

 

Margin requirements vary by asset and regulation, but the concept is the same across the board: small deposit, large exposure, amplified outcomes.

 

For example, a $10,000 position with a 10% margin means you only put down $1,000.

 

If the price moves in your favor by 5%, your gain is 5% of the full $10,000 ($500), not your $1,000 margin.

 

But if it moves against you by 5%, you lose $500.

 

Works both ways, no favorites here.

 

Leverage also works the other way. If the price moves against you, your broker may issue a margin call, requiring more funds to keep the position open. If you don’t add funds, the broker can close your position to limit further losses.

 

What about costs? Nothing’s ever free

CFDs may not come with management fees, but they do come with:

• Spread: The tiny difference between buy and sell prices.

• Overnight financing/funding (swap fees): It’s charged when you keep leveraged positions open past the trading day.

• Commission: It’s dependent on the broker and asset type.

These costs can stack up, especially for long-held positions, which is why CFDs are often used for short- to medium-term strategies rather than long-term investing.

 

CFDs offer broad market access, but they require careful risk management and discipline.

 

So why do people use CFDs?

Because they’re versatile. CFD trading allows you to:

• Access a wide range of global markets from one platform

• Trade rising and falling prices

• Use leverage to control larger positions

• Hedge existing portfolios

• Avoid ownership requirements or settlement procedures

 

Are they too risky, or just misunderstood?

This is the big question. CFD risks are real and not subtle. Leverage magnifies outcomes. Markets can move faster than expected. Volatility can wipe out positions before you blink.

 

But regulatory protections have improved dramatically. The measures don’t eliminate risk, but they do stop traders from losing more than they deposit, an issue that haunted early CFD markets.

 

Final thoughts

CFDs are useful but risky. They give traders access, flexibility, and leverage, but they require discipline and an understanding of how fast markets can move.

 

Used carefully, they can support a trading strategy. Used carelessly, they can lead to losses just as quickly.