A Contract for Differences, commonly known as CFD, is an agreement where the difference in settlement of a financial derivative’s open and close prices is resolved with a cash settlement. CFDs exist for multiple assets, including stocks, indices and commodities, although no delivery of actual goods or securities happen when trading a CFD.

CFDs are often traded on what is called leverage to give traders more trading power and flexibility. Leverage refers to the use of borrowed capital to increase the size of one’s position in order to potentially amplify gains.

Here’s an example of CFD trading:

The Agreement:

• Person A believes Gold is going to rise from $1,175.00 per oz
• Person B believes Gold is going to fall from $1,175.00 per oz

Therefore the two clients enter an agreement to settle the difference from $1,175.00.

The Outcome:

• Person A Buys 1 oz of Gold at $1,175.00
• Person B Sells 1 oz of Gold at $1,175.00

After 3 days, Gold is trading at $1,180.00. Thus, Person A has made a profit of $5 and person B has made a loss of $5.

• Person A closes the position at $1,180.00 and makes $5
• Person B closes the position at $1,180.00 and loses $5

In fact, trading CFDs isn’t all that different from trading traditional shares.

• If you buy 500 shares of a company at £5 then you will get £2500 worth of shares.
• If you buy 500 shares with a CFD at £5 then you will also get £2500 worth of shares.
• If the share price rises by 10% then you have made £250 from your share trade.
• If the share price rises by 10% then you will make a profit of £250 from your CFD trade.