Every week, we deliver bite-sized insights into popular assets and trending topics, helping you deepen your understanding of the investment market.
In this edition of Markets in Focus, we explore CFD trading - what CFDs are, how they function, and their origin story.
What Is CFD Trading?
A Contract for Difference (CFD) is a derivative financial instrument that allows traders to speculate on the price movements of various assets - such as stocks, indices, currencies, commodities, or cryptocurrencies - without owning the underlying asset.
CFD trading enables profit opportunities in both rising and falling markets.
How Does CFD Trading Work?
When you trade CFDs, you enter into a contract with a broker that reflects the price movement of an underlying asset. If the price moves in your favor, you make a profit; if it moves against you, you incur a loss. But you never take ownership of the actual asset.
For example:
- Suppose you believe Apple’s stock will rise. Instead of buying Apple shares, you buy a CFD on Apple at $240 per share.
- If Apple’s price climbs to $250, you profit $10 per share (difference between open and close).
- If Apple’s price falls to $230, you lose $10 per share.
With leverage, these gains or losses can be magnified. For instance, trading Apple CFD with 5× leverage would turn your $10 price movement into a $50 profit (or loss).
The Origins of CFDs
- CFDs were developed in the early 1990s by Brian Keelan and Jon Wood at UBS Warburg in London.
- Initially, they were used by hedge funds and institutional traders to hedge their equity exposure without owning the physical shares and to benefit from tax efficiency.
- CFDs started trading over-the-counter (OTC), making it possible to speculate on price movements without settlement of the underlying asset.
- In the late 1990s, CFDs became available to retail (individual) traders via online platforms.
Benefits & Risks of CFD Trading
Benefits:
- Flexibility: Trade a broad range of assets - from forex and indices to commodities and crypto — without owning them.
- Leverage: Use margin to control larger positions with less capital, amplifying potential returns.
- Short-selling: Ability to profit from falling markets by opening short positions.
Risks:
- High risk of loss: Leverage can multiply losses just as it multiplies profits.
- Complexity: Requires understanding of margin, financing costs, and risk management.
- Counterparty risk: CFDs are typically OTC instruments, meaning your broker is the counterparty.
- Regulatory warnings: Regulators often highlight that many retail traders lose money with CFDs.
Why Do Traders Use CFDs - and When to Be Cautious
CFDs are especially appealing for active traders who want to speculate on price movements without the hassle of owning the asset. They’re powerful tools when used wisely, but they’re not for everyone. Retail traders should only use CFDs if they understand the mechanics, risks, and how to manage their exposure.
If you’re exploring CFD trading, it’s vital to test in a demo environment, build a clear strategy, and never risk money you can’t afford to lose.
CFD Trading with Change
On the Change App, you can access CFD trading across stocks, currencies, commodities, indices, and crypto - all in a single, powerful platform.
Trade with flexibility, use leverage responsibly, and manage your risk intelligently.
Trade smarter. Stay informed. Manage your risk.
Wishing you a successful week of trading on Change!
Until next week!
