What is trading?
What is a CFD (and what you're actually trading)
Learning objectives
By the end of this lesson, you'll be able to:
Explain what a Contract for Difference is and what you hold when you open one
Describe how margin and leverage work, and why margin is not a cap on your loss
Name the three costs attached to a CFD position and what drives each one
The contract, not the thing
Contract for Difference. The name is the definition. It's an agreement between you and your broker to exchange the difference in an instrument's price between the moment you open a position and the moment you close it.
That's the whole product.
You do not own the underlying. Open a gold CFD and no gold is bought, moved or stored. Open a share CFD and your name goes on no shareholder register. Open a bitcoin CFD and no coin enters a wallet. The asset is a reference point the contract tracks, nothing more.
So when someone asks what you're trading, the accurate answer is: you're trading the price, and what you hold is a contract.
What actually happens when you open one
Four steps, identical for every instrument:
- You open. You pick a direction and a size. The opening price is recorded.
- The broker sets margin aside. A portion of your balance is reserved while the position is open. It stays in your account; you just can't use it for anything else.
- Your profit and loss updates live. Every tick, the platform recalculates the difference between your opening price and the current price, multiplied by your position size.
- You close. The difference is settled in cash. Moved your way, the broker credits your account. Moved against you, it debits it.
Direction behaves exactly as lesson 4 described. Long gains when the price rises, short gains when it falls, and a short CFD borrows nothing, because there's nothing to borrow.
Example: Anna thinks the euro will strengthen against the dollar. She buys €10,000 worth of EUR/USD through her broker. The price rises 0.7% over two days (about 70 pips — a pip is the standard unit of price movement; more on that in Foundations) and she closes, collecting roughly $70 before costs. If the price had fallen 0.7% instead, she'd have lost roughly $70. Both outcomes were always on the table — that symmetry is the honest heart of trading.
Margin and leverage
Lesson 1 promised we'd come back to leverage. Here it is, and it follows directly from everything above.
Because you never buy the asset, you never have to fund the asset's full value. You fund the margin instead. Illustrative numbers:
- Gold is $2,000 an ounce. You want one ounce of exposure.
- Your account's margin requirement on gold is 5%.
- You post $100. Your exposure is $2,000. That's leverage of 20:1.
Now the sentence that matters most in this lesson:
Your profit and loss are calculated on the $2,000, not on the $100.
Gold moves 5% in your favour and you make $100, which is all of the margin you posted. It moves 5% against you and you lose $100, which is also all of the margin you posted. A modest move in the underlying became a total move in your money.
That is what leverage does. It doesn't make you more likely to be right. It makes being right or wrong matter more.
Margin is a deposit, not a maximum loss
This misunderstanding costs beginners real money, so it gets its own heading.
Margin is what's required to open a position. Your risk is set by the size of the position. Two different numbers, and only one of them is capped.
If losses erode your balance, two things happen in order. First a margin call: a warning that your account no longer comfortably supports what you're holding. Then, if it continues, a stop-out: the broker closes positions automatically to prevent further loss. You don't get to choose when this happens.
Check whether your account carries negative balance protection, which prevents the balance falling below zero. It isn't universal, and it determines what the genuine worst case looks like. Find out before you deposit.
What it costs to hold a CFD
Three charges, each behaving differently:
- Spread. Charged once, at entry, as lesson 4 explained. Scales with position size and how often you trade.
- Commission. Applies on some account types and not others. Check yours.
- Overnight financing. Charged, or occasionally credited, every night you hold past rollover. This is the price of the leverage. Scales with how long you hold.
The Foundations path breaks all three down with numbers. The structural point for now is simpler: a CFD costs you something every day it stays open. That one fact shapes what the instrument is and isn't good for.
A contract has two parties. Yours is your broker.
Which means any profit you make is owed to you by that firm, rather than sitting in an asset you hold independently. That isn't a reason to avoid CFDs. It is a reason to know where your broker is regulated and how client money is held, before you deposit rather than after. Lesson 6 compares this directly against owning an asset outright.
Why trade CFDs?
CFDs solve three specific problems: taking a position in either direction with equal ease, taking one without funding its full value, and reaching currencies, indices, commodities and shares from a single account.
They solve none of them for free. You're leveraged, you're paying daily to stay in, and you own nothing.
That's a reasonable trade for a position measured in days or weeks. It's a poor one for a position measured in years, which is where lesson 6 picks up.
Key takeaways
A CFD is an agreement with your broker to exchange the price difference between opening and closing. You never own the underlying asset
Margin is the deposit required to open a position. Profit and loss are calculated on the full position size, so margin is not a cap on your loss
Losses that erode your balance trigger a margin call and then an automatic stop-out. Check whether your account has negative balance protection
A CFD costs you spread at entry and financing every night it stays open, which makes it an instrument built for short holding periods