How spread betting and CFD trading work
What are contracts for difference (CFDs)
Similarly to spread betting, when you trade a contract for difference, or CFD, you're not actually trading a physical asset. Instead you're agreeing to exchange the difference in value of an asset between the point at which the contract is opened and when it is closed.
Contracts for difference are derivatives, as the price of a CFD is derived from the value of an underlying asset. For example, you might open a CFD based on the price of gold, with the expectation the metal will rise in value. If the price of gold does indeed go up and you then close the contract, you will have made a profit. If it drops, you'll have made a loss.
Of course, the more the market moves in your favour, the more money you can make. And the further the market moves against you, the more your losses will stack up. Also, as you never own the physical asset, you can potentially profit from both rising and falling prices in the underlying market. In other words, you can go long or short.
This is probably beginning to sound quite familiar. At a first glance spread betting and CFDs can appear almost identical. Even the way CFDs are traded is remarkably similar.
Trading a CFD
Just like a spread bet, you'll see a two-way price quoted on each CFD market offered. Let's use silver as an example. Suppose it's currently being listed by one provider at a spread of 1650/1653 (which is the equivalent of $16.50/$16.53 in the underlying market).
- 1650 is the bid price at which you can 'sell' (go short)
- 1653 is the offer price at which you can 'buy' (go long)
If you believe the price of silver will rise, you 'buy' at the offer price. Or if you think it will drop, you 'sell' at the bid price.
And as with a spread bet, you'll be asked to put up a margin payment as a deposit to open your position.
However, things differ when it comes to deal sizes. With spread betting you bet an amount of money per point, but CFDs are traded in standardised contracts, sometimes called lots. The sizes of these contracts differ depending on the asset, often mimicking how that asset is traded in the underlying markets.
Going back to silver, it's traded in a contract size of 5000 troy ounces in the underlying market. Therefore most CFD providers also offer silver in a contract size of 5000 troy ounces. This works out to be the equivalent of $50 per point of movement.
- A CFD is an agreement to exchange money according to the change in value of an underlying asset
- It is a means to gain exposure to the change in value of a financial instrument without actually owning that instrument
- Traders can take a long or short position on a CFD, potentially enabling them to profit from falling as well as rising prices
- CFDs are traded in standardised contracts called lots, which differ in size for each asset