Contract For Difference (CFD)

Contract For Difference (CFD)

Contracts for difference (CFDs) are cash-settled financial contracts that allow you to trade without owning the underlying asset. Find out how they work.
By: Harry Atkins
Harry Atkins
Harry joined us in 2019, drawing on more than a decade writing, editing and managing high-profile content for blue… read more.
Updated: Feb 24, 2021
0/5 Star rating
Beginner
4 min read

Trading stocks as a contract for difference (CFD) is a popular way of gaining exposure to the broader stock market. CFDs differ from the traditional way of buying stocks and rose to prominence in the UK through the increase in CFD brokers. A CFD is a financial derivative that allows investors to speculate on the prices of underlying assets. With CFDs, you can speculate on the prices of stocks, commodities, stock indexes, and other securities.

Stock CFDs, which are some of the most frequently traded financial derivatives, allow traders to speculate on the prices of stocks without owning the underlying asset. They differ from company in that you do not own the shares outright.

A CFD allows traders to enter into an agreement and trade financial instruments based on price fluctuations. In the stock market, CFDs allow traders to leverage their trading by only having to invest a small margin deposit in owning a trading position, and speculate on price movements.

I. Key Traits of CFDs

  • With stock CFDs, you do not own actual shares of a company
  • Stock CFDs allow traders to enter long and short positions on any stock
  • Stock CFDs can be used as hedging tools
  • Stock CFDs attract overnight swap rates
  • There are no shareholder privileges with CFDs of stocks
  • You can trade CFDs using leverage to amplify profits

II. Stock CFD Trading Terms

Going Long

CFD stock trading is all about price speculation. Going long translates to a trader speculating that the price of a stock in question will increase upon buying. If correct and the price goes up, the trader would make a profit on the difference between the buying price and the closing price.

Going Short

Going short is the opposite of going long, where the trader speculates that a CFD stock is overvalued, and the price is destined to decrease. In this case, a trader opens a short position, which is essentially a sell. Should the price edge lower, the trader would be able to make a profit on the price difference between where he opened the sell position and the final price.

Margin and Leverage

In CFD stock trading, investors don’t need to deposit the full value of the stock they wish to buy. Stockbrokers offer what is often referred to as leverage, a device that amplifies the initial capital, allowing traders to buy stocks worth more than their invested capital.

For instance, if a stock is trading for $100, you would need $10,000 to own 100 shares. However, with CFDs, you would only need $200, assuming a leverage of 1:50.

The invested capital is referred to as margin. The benefit of using leverage in CFD stock trading is that it can amplify profits. However, being a double-edged sword, it also amplifies losses should a trade go against a trader.

III. Advantages of Trading Stock CFDs

Stock CFDs are some of the best for investors who do not have the full amount of capital needed to buy stocks of companies. The availability of heavy leverage makes it possible to enter trades where normal capital wouldn’t be sufficient.

The ability to enter both long and short positions allows investors to take advantage of prices going either up or down. Owning stock CFDs also entitles investors to perks, such as dividends.

Stock CFDs trade on fast-moving global financial markets, providing direct market access that accords traders an opportunity to trade them globally.


Fact-checking & references

Our editors fact-check all content to ensure compliance with our strict editorial policy. The information in this article is supported by the following reliable sources.

Risk disclaimer

Invezz is a place where people can find reliable, unbiased information about finance, trading, and investing – but we do not offer financial advice and users should always carry out their own research. The assets covered on this website, including stocks, cryptocurrencies, and commodities can be highly volatile and new investors often lose money. Success in the financial markets is not guaranteed, and users should never invest more than they can afford to lose. You should consider your own personal circumstances and take the time to explore all your options before making any investment. Read our risk disclaimer >

Harry Atkins
Financial Writer
Harry joined us in 2019, drawing on more than a decade writing, editing and managing high-profile content for blue chip companies, Harry’s considerable experience in the… read more.

Related courses

Choosing the right stock to invest in needs time and care; it is never something that can be done on a whim. From the type of company you are investing in and its financial status to overall market conditions and the need to mitigate risk, there are a variety…
Investing in the stock market is one of the best ways to make money and grow your wealth. Stock investing can serve as a reliable passive income stream that protects your capital against inflation. In addition, many companies share a portion of their profits with investors in the form of…
Luckily, it’s far easier to begin trading than it was in the 90s when Wall Street and big money were the only options. Get started with our introduction to stock trading. You’ll come away feeling more confident about the task ahead, while acquiring a base knowledge of all the most…