What are CFDs?
‘CFD’ stands for ‘contract for difference’. These are leveraged financial derivatives that allow traders to speculate on whether an underlying market will rise or fall in value over a set period, without taking ownership of the assets, regardless of whether you're trading Forex, indices, commodities, or bonds.
A CFD is essentially a contract between a trader and a CFD broker to settle the difference in the price of an underlying asset between the time a position is opened and when it's closed.
When trading CFDs, you would open a long (buy) position if you expect the price of an asset to rise, or open a short (sell) position if you expect it to fall.
Looking to learn more? Read our ‘What is CFD trading?’ guide for an in-depth explanation.
Example of CFD trading
Let’s say a trader believes that shares in Google are likely to continue rising. They could buy (go long) 10 CFDs on Google shares at $100 each, for a total of $1,000.
Each of these CFDs is worth $1 in movement in the company’s share price. Therefore, if the share price rises to $110 by the end of the contract, the trader would have made a $100 profit.
You can calculate your profits from CFD trading by multiplying the number of units bought or sold by the change in the market’s share price: profits = (closing price – opening price) x position size. In other words, ($110 - $100) x 10 = $100.
The same applies to bear markets; if you expect Google share prices to drop, the trader could sell 10 CFD units at $100 each, making a profit of $100 if the price falls to $90.
If the share price were to fall from $100 to $90, the trader would have had a loss of $100.
Losses are calculated similarly, losses = (opening price – closing price) x position size, e.g. ($100 - $90) x 10 = $100.
What are futures?
Like CFDs, future contracts are financial derivatives that allow you to predict whether an underlying market will rise or fall. However, the main difference is that both the buyer and seller arrange to trade an asset at a set price on a chosen date in the future.
For example, a trader might look at the price of crude oil in May and expect its cost to rise over the next two months. In this scenario, the trader could open a long position on oil for August. If the price of oil rises above the original contract price, then the trader would earn a profit. Conversely, if the price of oil drops below the original price, then the trader would have a loss.
When trading futures, your potential profit or loss depends on how much your chosen asset has risen or fallen in price, as well as the size of your position.
What are the similarities and differences?
Both CFDs and futures are popular derivative products that allow you to diversify your trades and predict the outcome of underlying markets. You could either go long if you predict the market's price will increase or go short if you predict the market will experience a decline. However, each one of these products has its own advantages and disadvantages
Futures are traded on regulated exchanges. This means they have set trading hours, centralised prices, and standardised contracts. They’re ideal for traders looking to manage their risk, though there is still a possibility of losing money, as with any asset.
CFDs, on the other hand, offer more flexibility. They can vary in duration, and their higher leverage makes them easily accessible for new traders, but their more lenient regulation means they’re less centralised.
The key difference between futures and CFDs lies in how their costs are calculated. Futures are contracts that two parties are bound to make a set trade at a set time, while CFDs mimic the price of an underlying asset, enabling you to trade on its price movements, whether it's bullish or bearish.
