The contract for difference (CFD) offers European traders and investors an opportunity to profit from price movement without owning the underlying asset. It's a relatively simple security calculated by the asset's movement between trade entry and exit, computing only the price change without consideration of the asset's underlying value. This is accomplished through a contract between client and broker, and does not utilize any stock, forex, commodity or futures exchange. Trading CFDs offer several major advantages that have increased the instruments' enormous popularity in the past decade.

How a CFD Works




Contract for Differences (CFD)

The Advantages:

Higher Leverage

CFDs provide higher leverage than traditional trading. Standard leverage in the CFD market is subject to regulation. It once was as low as a 2% margin (50:1 leverage); but is now limited in a range of 3% (30:1 leverage) could go up to 50% (2:1 leverage). Lower margin requirements mean less capital outlay for the trader/investor, and greater potential returns. However, increased leverage can also magnify losses.

Global Market Access from One Platform

Many CFD brokers offer products in all the world's major markets, allowing around the clock access.

No Shorting Rules or Borrowing Stock

Certain markets have rules that prohibit shorting, require the trader to borrow the instrument before selling short or have different margin requirements for short and long positions. CFD instruments can be shorted at any time without borrowing costs because the trader doesn't own the underlying asset.

Professional Execution With No Fees

CFD brokers offer many of the same order types as traditional brokers including stops, limits and contingent orders like "One Cancels the Other" and "If Done." Some brokers offer guaranteed stops that charge a fee for the service or recoup costs in another way. Brokers make money when the trader pays the spread and most do not charge commissions or fees of any kind. To buy, a trader must pay the ask price, and to sell/short, the trader must pay the bid price. This spread may be small or large depending on volatility of the underlying asset and fixed spreads are often available.

No Day Trading Requirements


Variety of Trading Opportunities

Brokers currently offer stock, index, treasury, currency, sector and commodity CFDs so speculators in diverse financial vehicles can trade CFDs as an alternative to exchanges.

The Disadvantages

Traders Pay The Spread

While CFDs offer an attractive alternative to traditional markets, they also present potential pitfalls. For one, having to pay the spread on entries and exits eliminates the potential to profit from small moves. The spread also decreases winning trades by a small amount compared to the underlying security and will increase losses by a small amount. So, while traditional markets expose the trader to fees, regulations, commissions and higher capital requirements, CFDs trims traders' profits through spread costs.

Weak Industry Regulation

Also note the CFD industry is not highly regulated and the broker's credibility is based on reputation, longevity, and financial position rather than government standing or liquidity. There are excellent CFD brokers, but it 's important to investigate a broker's background before opening an account.


CFD trading is fast-moving and requires close monitoring. There are liquidity risks and margins you need to maintain; if you cannot cover reductions in values, your provider may close your position, and you'll have to meet the loss no matter what subsequently happens to the underlying asset. Leverage risks expose you to greater potential profits but also greater potential losses. While stop loss limits are available from many CFD providers, they can't guarantee you won't suffer losses, especially if there's a market closure or a sharp price movement. Execution risks also may occur due to lags in trades. Partly for these reasons, they are banned and unavailable to residents in the U.S.

The Bottom Line

Advantages to CFD trading include lower margin requirements, easy access to global markets, no shorting or day trading rules and little or no fees. However, high leverage magnifies losses when they occur, and having to pay a spread to enter and exit positions can be costly when large price movements do not occur. Indeed, the European Securities and Markets Authority (ESMA) has placed restrictions on CFDs to protect retail investors.