Derivatives · Intermediate · 4 min

How CFDs work

You can explain how a CFD pays out the price difference, why it is an OTC contract with the provider, and how it differs from owning the underlying.

What's inside a CFD

The ads are everywhere: trade shares, indices, currencies, gold and crypto, long or short, from a small deposit, in one app. Behind almost all of them is the same product: the CFD.

CFDs are the most common leveraged product for private traders in Europe. They are also the product that led EU regulators to step in. This lesson explains what a CFD actually is, before the next lessons cover its costs and safeguards.

Price difference, with leverage

A contract for difference, or CFD, is an agreement between you and a provider. When you close the position, the difference between the opening and closing price is paid, multiplied by the position size:

if you bought and the price rose, the provider pays you,
if you bought and the price fell, you pay the provider,
and the opposite if you sold first.

Four features define a CFD:

No ownership. You never own the underlying share, coin or barrel. There are no shareholder votes and, in most cases, no direct claim on the asset.
Leverage. You post margin, a fraction of the exposure. ESMA's rules cap leverage for retail clients: 30:1 for major currency pairs, 20:1 for other pairs, gold and major indices, 10:1 for other commodities and minor indices, 5:1 for individual shares and 2:1 for crypto assets.
Long or short. Selling first is as easy as buying, without borrowing anything.
OTC. The contract is with the provider, not on an exchange. As the lesson on OTC derivatives explained, the provider sets the prices and is often your counterparty.

In return for the convenience, CFDs carry ongoing costs, especially financing for positions held overnight, as the next lesson explains.

±4% price, ±20% margin

A fictional trader buys a CFD on 100 shares of a company trading at 100, so an exposure of 10,000.

At 5:1 leverage, the trader posts 2,000 of margin.
The share rises to 104. The CFD pays 4 × 100 = 400, a gain of 20% on the margin.
Had it fallen to 96, the trader would have lost 400, 20% of the margin.

Owning the shares directly would have meant gains or losses of 4% on 10,000 invested. The CFD needed less money and magnified the result in both directions.

Common mistakes

Thinking you own the asset. You hold a contract with the provider.
Using maximum leverage. It turns normal moves into large swings.
Ignoring the provider. Its prices, costs and stability decide your result.
Treating short CFDs as harmless. Losses grow as prices rise.

The takeaway

A CFD pays the difference between opening and closing price, with leverage. You never own the underlying, and your contract is with the provider.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the step in which the CFD's result is settled.

Tap the chart.

When the position is closed, the price difference times the size is paid, by the provider or by you.
2Do you own the shares when you buy a share CFD?

A CFD gives price exposure only. There are no shareholder rights, and the contract is OTC.
3You buy a CFD on 100 shares at 50 with 5:1 leverage. How much margin do you post?

Exposure 5,000, leverage 5:1, so margin is 5,000 ÷ 5 = 1,000. That is ESMA's limit for individual shares.
4Why can you go short with a CFD as easily as long?

No borrowing is needed. If the price falls, the provider pays you the difference.

of 4 correct.