What are CFDs and how do they work?

You never hold shares, barrels of oil, or ounces of gold. The contract tracks the price of whatever asset it references. That makes CFDs a way to get exposure to markets a trader might not otherwise access easily, like foreign stocks or index-level moves.

How a CFD trade works step by step

A trader picks an asset. Say Apple shares. They decide whether the price will go up or down. If they think the price will rise, they open a buy position. If they think it will fall, they open a sell position, also called going short.

The broker shows a bid-ask spread. The buy price is slightly above the market price. The sell price is slightly below it. That spread is the broker's fee for the trade. Some brokers also charge commission separately. Others build the fee entirely into the spread.

The trader sets the contract size. For Apple, one CFD might equal one share. For a stock index like the FTSE 100, one CFD might equal a fixed cash amount per point of movement. The contract size determines the dollar exposure per unit of price move.

Margin comes next. CFDs are leveraged products. The trader does not put up the full contract value. They put up a percentage, often between 5% and 20%, depending on the asset class and the broker's rules. That margin sits in the account as collateral. The broker effectively lends the rest.

The trade runs until the trader closes it. At close, the broker calculates the difference between the opening price and the closing price, multiplied by contract size. That difference is the profit or loss. If the trade lost more than the margin, the trader owes the shortfall.

A concrete example

A trader opens a buy CFD on 100 shares of Company X at GBP 50 per share. The contract value is GBP 5,000. The broker requires 10% margin, so the trader puts up GBP 500.

The stock rises to GBP 55. The trader closes. The difference is GBP 5 per share times 100 shares equals GBP 500 profit.

Had the stock fallen to GBP 45, the difference would be minus GBP 5 times 100 equals a GBP 500 loss. That would wipe the margin. The broker would issue a margin call or close the position automatically.

Where the leverage matters

Leverage magnifies gains and losses equally. A 10% move in the underlying stock becomes a 100% return on the margin in this example. A 10% drop becomes a total loss of the margin. Some brokers offer leverage ratios of 30 to 1 or higher on major assets. That means a 3.3% move in the wrong direction can lose the entire margin.

This is the risk that catches beginners off guard. The account can lose not just the margin but more than the margin if the market gaps past the stop or if the broker does not close the position fast enough. Some jurisdictions, like the UK and EU, cap retail CFD leverage at 30 to 1 for major forex pairs and lower for crypto, stocks, and commodities. That rule exists because regulators saw traders blowing up accounts repeatedly.

Short selling with CFDs

CFDs are one of the few ways retail traders can bet on falling prices without borrowing shares. Opening a sell CFD means the trader profits if the price drops. The process is the same as a buy trade. The trader picks a contract size, posts margin, and closes later. The direction just flips.

Short selling through CFDs carries the same margin risk as buying. Plus, in theory, losses on a short trade are unlimited if the underlying price keeps rising. In practice, brokers enforce stop losses or have automatic close-out rules for open short positions.

Costs beyond the spread

Overnight financing charges apply to CFD positions held past a certain time, usually 5 p.m. New York time. The charge reflects the cost of the leverage the broker provides. For short positions, the trader might receive a credit instead of paying, but the rate is usually unfavorable compared to holding the position directionally positive. Some brokers also charge a fee for guaranteed stop losses or for inactivity on accounts.

Dividends also affect long and short CFD positions differently. If a trader holds a long CFD through an ex-dividend date, the broker credits the dividend amount. If the trader holds a short CFD through that date, the broker debits the dividend amount. These adjustments are automatic in most platforms.

Where CFDs are restricted

CFDs are banned for retail traders in the United States. The SEC and CFTC consider them unsuitable for retail clients under their rules. They are widely available in the UK, Europe, Australia, Singapore, South Africa, and the Middle East. Traders based in the US cannot open CFD accounts with most international brokers, though some try through offshore providers. That carries additional legal and enforcement risk.

What beginners should do first

A demo account is the standard starting point. Most CFD brokers offer one for free. It runs on live market data but uses fake money. The trader can test strategies, understand the spread costs, see how leverage affects the P&L, and learn how margin calls work without risking real capital. A month on demo before putting real money in is a common recommendation.

The regulatory picture

Reputable CFD brokers are licensed in their home jurisdiction. In the UK, that means authorisation by the Financial Conduct Authority. In Europe, it means regulation by the local financial authority under ESMA rules. Brokers licensed in Cyprus, Malta, or the British Virgin Islands have different rules and weaker investor protection. Check the license before sending money.

Trading CFDs carries high risk. The European Securities and Markets Authority found that between 74% and 89% of retail CFD accounts lose money, depending on the broker. Those numbers come from mandatory disclosures on broker websites. The losses are not bad luck. They are a structural outcome of leverage costs, spread costs, and position sizing errors.

What CFDs are not

CFDs are not investments in the traditional sense. There is no ownership, no voting rights, and no claim on the company's assets if it goes bankrupt. They are short-term trading instruments designed for speculation. A trader holding a CFD for years pays financing costs that eat deeply into any theoretical profit. They are not a substitute for buying shares or ETFs in a long-term portfolio.

One checklist for a first trade

Before opening a real position, a trader should know the contract size per point, the margin percentage, the spread in pips or cents, the overnight financing rate, and the stop loss rules. Most platforms show these numbers before the trade is placed. The trader should also know their stop loss level and the dollar loss that level represents if the trade moves against them. If that loss would hurt the account, the position is too large.

CFDs are a tool, not a strategy. The strategy comes from the trader's analysis of the underlying asset. The CFD just provides the execution. The same chart reading, news awareness, and risk management that apply to any traded market apply here. The leverage makes the consequences of mistakes bigger.