What is CFD Trading?

By January 7, 2015 Trading Academy

The definition of a CFD (or Contract For Difference) is an agreement to exchange the difference in value of a particular market between the time at which the contract is opened and the time at which it is closed.

CFDs are one of many forms of investing and trading FX, Commodity and Stock Index markets, regulated by the UK’s Financial Conduct Authority (FCA).

How Does it Work?

With CFDs you do not actually own the underlying asset that you are trading because it is a derived instrument. The prices that we provide you are derived from the underlying asset and these prices move in conjunction with that underlying asset.

This diagram shows how your profit is calculated depending on whether you buy or sell the market, assuming you buy 1 CFD:

Once you have chosen the market on which you wish to trade, you can then trade as many CFDs as you wish, which will represent your profit or loss per point movement in that market (each market has its own individual maximum allowable trade size).

You can choose to bet that the market will rise (Buy or Go Long), or alternatively, you can bet that it will fall (Sell or Go Short). If you are right, you will make a profit of your number of CFDs multiplied by each point that the market moves in your favour. If you are wrong you will make a loss of your number of CFDs multiplied by each point that the market moves against you.

For this reason you must be aware that your losses can increase dramatically if the markets move substantially in the opposite direction to your trade (i.e. if you BUY ABC 100 and instead of going up it goes down).

In all markets, there is a “spread” which refers to the difference in Sell (Bid) and Buy (Offer or Ask) price quoted by a broker. A CFD price always has two parts. The first is the BID or price you can sell at. The second is the ASK or the price you can buy at. This price is calculated by adding additional points around the live (or the estimated future) market price of a financial product. For example, if the Daily FTSE is betting at 5000.5 our quote might be 5000.0-5001.0.

CFD Trading compared to Stocks.

Traditional Stock Broker

ROCE working: 4750 ÷ 14000 x 100%
Buy 10,000 shares @ 140p
Cash outlay (£14,000)
Sell 10,000 shares @ 200p
Gross profit £6,000
Stamp duty (£70)
Commission (buy/sell) (£100)
Tax @ 18% (£1,080)
Overnight financing £0
Net Profit £4,750
Return on Capital Employed 34%

Price Markets

ROCE working: 4873.6 ÷ 1401 x 100%
Buy 10,000 CFDs @ 140.1p
Cash outlay* (£1,401)
Sell 10,000 CFDs @ 199.9p
Gross profit £5,980
Stamp duty £0
Commission (buy/sell) £0
Tax @ 18% (£1,076.4)
Overnight financing (£30)
Net Profit £4,873.6
Return on Capital Employed 347%

** CFD’s are exempt from UK Stamp Duty. Tax treatment depends on the individual circumstances of each client and may change in the future.

Remember that the risk is still the same for either scenario.

As with all CFDs you do not own or owe the underlying asset. So, if you open a buy CFD on a share you will not have any voting rights.

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CFD Trading involves significant risk.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.
64.4% of retail investor accounts lose money when trading CFDs with this provider.
You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.
Professional clients can lose more than they deposit. CFD trading involves significant risk.
Read full Risk Warning Notice.

Price Markets UK Ltd (Price Markets) is a company registered in England and Wales under registered number: 09597543.
Price Markets is authorised and regulated by the Financial Conduct Authority (FCA) under firm reference number: 725804.

Office: 60 Gresham Street, London EC2V 7BB, United Kingdom.
Registered address: 35 Ballards Lane, London N3 1XW, United Kingdom.