What is a CFD?

CFD stands for ‘Contract for Difference’. A CFD is an agreement between two parties, typically called a ‘buyer’ and ‘seller’, where the buyer agrees to pay the seller the difference between the opening and closing price of a CFD contract at the time the CFD position is closed. A CFD is a type of financial instrument that allows speculation on the price of shares indices, commodities and many other financial products without actually purchasing or owning the underlying asset.

CFDs are typically traded between individual traders and CFD providers. There are no standard contract terms for CFDs, and each CFD provider can specify their own, but they all tend to have a number of things in common.

The CFD is started by making an opening trade on a particular instrument with the CFD provider. This creates a ‘position’ in that instrument. In order to close a position, a trade that is equal in size but opposite in direction to the existing position must then be done. For example, if you are currently long 1 Lot of FTSE 100, you must then sell 1 Lot of FTSE in order to close the position. Once the position is closed the difference between the opening price and closing price is paid as profit or loss in to the account.

CFD contracts may or may not have expiry dates, depending on the nature of the product. If the CFD does have an expiry date it will typically be a month or several months in the future. Up until the expiry time any positions that are left open overnight are ‘rolled over’ in to the next day. This means that the positions are not closed out at the end of the day continue running until they are closed out either by the trader of the CFD or the CFD provider. The CFD provider may make a number of charges as part of the trading or the open position. These may include bid-offer spread, commission, overnight financing and account management fees.

 

The Risks!

If you happened to have sold originally rather than bought because you thought the market was going to go down but instead the market rose as described above, then you would be looking at a £880 loss rather than a profit, as the market would have moved an equal amount against your view.