CFDs definition

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Contracts for difference, or CFDs, are a type of financial derivative used in CFD trading. They act as an agreement between two parties to exchange the difference in price of an asset from when the CFD position is first opened to when it is closed.

CFDs are traded on leverage, which means that all trades have magnified profits and losses. 

As a derivative, CFDs allow traders to speculate on market volatility without actually owning any of the underlying assets involved. That also means that assets can be both bought (going long) or sold (going short), and profits can be made from both bull and bear markets: though losses can be incurred also.

They can be used to trade a variety of financial markets like shares, forex, commodities, indices or bonds. CFDs are traded in contracts: you take out a certain number of contracts, and each is equal to a base amount of the underlying asset. One contract is equal to a trade of £10 per point on the FTSE, for example.

CFD example

You open a long CFD position on Lloyds Banking Group when it is trading at 80p a share, buying 10,000 shares of Lloyds Banking Group as a CFD. Lloyds Banking Group shares then increase to 85p. You close the position by selling a CFD of 10,000 Lloyds shares, realising a profit of £500.

If the market had instead dropped to 75p and you closed your position, you would realise a loss of £500.

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