CFDs Explained: Leverage Without The Guesswork

A contract for difference, or CFD, lets you take a position on the price of an asset, such as an index, a currency pair or a commodity, without owning the asset itself. You and the broker agree to exchange the difference in price between when the trade opens and when it closes.

How it works

If you buy a CFD and the price rises, you receive the difference. If it falls, you pay it. You can also sell first, which lets you benefit from falling prices.

Leverage cuts both ways

CFDs are traded on margin. You only deposit a fraction of the position's full value. With 1:20 leverage, a $1,000 deposit controls a $20,000 position. A 5% move in your favour doubles the deposit. A 5% move against you wipes it out.

Leverage does not change the market. It changes how much each move costs you. That is why most retail CFD accounts lose money: the position is too large for the account.

How professional desks size positions

• Risk is set first. Decide the maximum loss for the trade as a share of the account before entering.
• The stop decides the size. The distance to the stop loss and the risk amount together give the position size, never the other way round.
• Volatility is respected. When markets move more, positions shrink.
• Total exposure is capped. Several correlated positions can add up to one large bet.

Costs to understand

CFDs carry a spread on every trade, and positions held overnight usually pay a financing charge. Over time these costs matter as much as entry and exit.