CFD Trading Explained: Costs, Leverage and the Real Risks

A contract for difference is a simple instrument described badly. Most explanations open with a worked example showing a large gain on a small deposit, then treat the costs and the restrictions as footnotes.

The order is backwards. Three numbers govern a CFD position, and most published examples name only one of them. Financing is charged on a base that guides rarely state. And in several major markets the instrument is not available to retail clients at all, for reasons worth understanding before opening an account anywhere else.

What follows sets out the mechanics, the full cost structure, the jurisdiction question, and what the loss statistics quoted on every broker site actually mean.

What a Contract for Difference Actually Is

A contract for difference is an agreement between a client and a provider to exchange the difference in the price of an asset between the moment a position is opened and the moment it is closed.

Nothing is delivered. Buying a share CFD does not make you a shareholder, and selling one does not require borrowing stock. The entire position is a cash settlement of a price difference.

Two consequences follow. Short positions are as straightforward as long ones, because there is no asset to locate and borrow. And the rights attached to ownership, principally voting and the legal claim on a dividend, do not come with the position.

The provider is the counterparty. That makes the financial standing and regulatory status of the firm part of the risk of the position, in a way it is not when an asset is held at a custodian.

Notional, Margin and Equity Are Three Different Numbers

Published CFD examples routinely blur these, and one widely cited explainer presents the notional value of an oil position as the amount invested before showing the gain. Keeping them apart is most of what makes the instrument comprehensible.

The relationship that matters is that gains and losses are computed on the notional while they are absorbed by the equity. A position whose notional is many times the equity can therefore lose a large fraction of the account on a small percentage move in the asset.

Most published examples show the first of those three sentences and stop. The second and third describe the same position and are equally a consequence of the structure. Sizing a position so that the third case cannot occur is the subject of risk management, and the arithmetic linking margin to exposure is worked through in the leverage calculator.

How much margin is held also depends on the leverage schedule the broker applies, because a banded schedule prices each slice of a position separately. Our page on tiered leverage sets out that calculation.

The Costs: Spread, Commission and Overnight Funding

Three costs apply, and they behave differently from one another.

The spread is the difference between the buy and sell price. It is charged once per round trip, in the sense that a position opened at the offer and closed at the bid pays it on entry and again on exit. It is a fixed cost of taking the position at all.

Commission is charged separately on some instruments, share CFDs most commonly, and is usually a percentage of the notional or a per-unit amount. Where a provider charges commission it generally quotes a tighter spread, so the two have to be compared together rather than separately.

Overnight funding, sometimes called a financing charge or a swap, applies only to positions held past a daily cut-off time. It is the cost of the leverage itself, and it is the one cost that grows with time.

The price actually received when an order executes is a further consideration, particularly on fast markets, and is covered in slippage.

Why Overnight Funding Is Charged on the Whole Position

This is the mechanic most guides name and none of the readable ones explain.

A leveraged position is economically a financed one: the provider supplies the difference between the notional and the margin posted. The funding charge is the price of that difference, so it is computed on the full notional value of the position, not on the margin.

The consequence is that leverage raises the carrying cost in the same proportion as it raises the exposure. Doubling the notional against the same deposit doubles the daily funding charge as well as doubling the profit and loss. The same relationship governs perpetual futures, where the charge is passed between traders rather than to the provider.

Two further points follow. Funding is normally applied on a per-day basis, so one day each week attaches several days of charges at once where a weekend intervenes. And a short position is not automatically credited: the charge is built from a benchmark rate adjusted by the provider, and on many instruments both directions are debited.

Dividend and Corporate Action Adjustments on Share CFDs

Only one of the readable sources reviewed for this page addresses this, and it matters to anyone holding share CFDs across a dividend date.

A share price typically falls by approximately the dividend amount when the stock goes ex-dividend. A CFD tracks the price, so without an adjustment a long position would lose that amount for no reason connected to the market.

Providers therefore apply a cash adjustment. A long position receives a credit approximating the dividend, and a short position is debited an amount approximating it. That debit surprises people who are short across an ex-dividend date and had not expected a cost.

The adjustment is not a dividend. It is a cash entry made by the provider, it may be net of a notional withholding, and it does not carry the tax treatment of dividend income. Anyone holding CFDs for income rather than for a price view is using the wrong instrument.

Corporate actions such as splits, consolidations and rights issues are handled by adjusting the position, and providers set out their own approach in the contract terms rather than following a market-wide rule.

Where CFDs Are Restricted and Why

Two of the three readable sources never raise this, and the third mentions only its own commercial restrictions.

Retail CFDs are not offered in the United States, and the reason is structural rather than a single prohibition.

Under the Commodity Exchange Act, leveraged, margined or financed retail commodity transactions must, absent an exception, be executed on a designated contract market registered with the Commodity Futures Trading Commission. Off-exchange arrangements with retail customers by firms outside the enumerated categories fall foul of the Act.

Separately, federal securities laws impose their own requirements on security-based swaps offered to retail investors.

An over-the-counter contract settled bilaterally between a client and a provider does not fit those requirements, so the instrument is not made available to US retail clients.

Elsewhere the instrument is permitted but constrained. The European Securities and Markets Authority restricted retail CFDs through its 2018 product intervention measures.

Those measures had five components: leverage limits by asset class, a margin close-out rule applied per account, negative balance protection per account, a prohibition on trading incentives, and a standardised risk warning carrying each firm’s own loss percentage. They were temporary, and national regulators subsequently adopted their own permanent equivalents.

The practical implication is that the protections attached to a CFD account depend on where the provider is authorised and which entity holds the account, not on the instrument. The same brand can offer materially different protection through different entities.

What the Retail Loss Statistics Do and Do Not Tell You

A figure between 74 and 89 per cent circulates constantly, usually presented as the proportion of retail CFD accounts that lose money. It is worth being exact about where it comes from.

That range is drawn from analyses by national competent authorities cited in the European Securities and Markets Authority product intervention measures on CFDs and binary options, which applied to CFDs from August 2018. It is a supervisory finding from that period, not a live statistic, and it has been repeated ever since as though it described current conditions.

What replaced it is more useful. The standardised risk warning requires each firm to publish its own current percentage of retail accounts losing money. That figure is specific to the provider, is updated, and is displayed on the provider’s own materials.

So the number to look at is the one on the site of the firm being considered, not the range quoted in articles. Two providers can differ, and their figures say something about their client base and product mix that a decade-old range cannot.

One caution about reading any of them. The percentage counts accounts, not money, and it says nothing about how much was lost or over what period. It is a useful indication of base rates and a poor basis for any conclusion about an individual outcome.

Who CFDs Are Not For

CFDs suit a trader who wants short-term, two-directional exposure to a price, understands that the position is financed, and is sizing by notional rather than by deposit.

They do not suit anyone building a long-term holding. Funding accrues every night the position is open, so a multi-year holding pays for its leverage continuously while an owned asset does not.

They do not suit anyone seeking income. The dividend adjustment is a cash entry rather than a dividend, it can be a debit on a short position, and it does not carry the treatment of dividend income.

They do not suit anyone who wants the rights of ownership. No voting rights and no legal claim on the underlying come with the position.

They do not suit an account small enough that the minimum position on an instrument would put a large share of the equity at risk on an ordinary move. The relevant comparison is the notional against the equity, not the margin against the equity.

Anyone whose interest is in a specific asset class should also check whether a more suitable instrument exists in their jurisdiction. Where the underlying is a cryptocurrency, the particular characteristics are set out in crypto CFDs, and the mechanics of entering and protecting a position are covered in order types.

Frequently Asked Questions

Do you own the underlying asset when you trade a CFD?

No. A contract for difference settles the difference between the opening and closing price in cash, and nothing is delivered. That means no voting rights and no legal claim on a dividend, and it also means a short position needs no stock to be borrowed. The provider is the counterparty to the contract.

How is overnight funding on a CFD calculated?

It is charged on the full notional value of the position rather than on the margin posted, because the provider is financing the difference between the two. It is built from a benchmark rate adjusted by the provider, applied per day to positions still open at a daily cut-off, and on many instruments both long and short positions are debited rather than one being credited.

Why can US retail traders not open CFD accounts?

Under the Commodity Exchange Act, leveraged retail commodity transactions must generally be executed on a designated contract market registered with the Commodity Futures Trading Commission. A bilateral over-the-counter contract does not meet that requirement, so providers do not offer the instrument to US retail clients.

What does the retail loss percentage on a provider website mean?

It is the current percentage of retail client accounts at that firm that lose money, published under a standardised risk warning requirement. It is specific to that provider and is updated, unlike the 74 to 89 per cent range widely quoted in articles, which comes from supervisory analyses cited in 2018 product intervention measures. The figure counts accounts rather than amounts.

Do share CFDs pay dividends?

Not as dividends. Providers apply a cash adjustment when a stock goes ex-dividend, crediting long positions an amount approximating the dividend and debiting short positions. It may be net of a notional withholding and it does not carry the tax treatment of dividend income, so a CFD is not a substitute for holding a share for income.