Contracts for difference

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1. What are CFDs?

CFD stands for 'Contract for Difference'. Strange as it sounds, the term accurately describes the nature of the trade: CFD traders speculate on the movement of a share price or index between the opening and closing dates of a 'contract', and the amount they gain or lose is calculated by the 'difference' between the two prices.

Let's kick off with a simple example:

You might buy a CFD equivalent to 3,000 Marks & Spencer shares when they have a bid/offer of 399/401. Two weeks later, when they have shot up to 431p, you might close the CFD by selling. Your profit, excluding commission and other costs, would be:

Sell price (£4.31) - Buy Price (£4.01) x Quantity (3,000) = £900

Note that:

The contract relates to a particular underlying share (or index), in this case M&S, and a particular number of them, in this case 3,000.
You buy and sell the CFD, not the shares; at no point do you actually own shares.
The contract does not have a fixed expiry date, but closes when you choose to close it.

A key feature of CFDs is that their bid/offer price is always the same as, or extremely close to, the bid/offer of the underlying share. So if M&S shares have a bid/offer of 399/401, so will the CFD. If the bid/offer on the shares rise, brokers will move their bid/offer on the CFD accordingly.

So far, so simple! Let's leave this page with two important lessons under our belt:

When you trade CFDs, you speculate on a rise or fall in the price of a share or an index, rather than in the share itself.

At no point do you actually own the underlying share.

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