How a CFD Works

contract for difference (CFD)  is a tradable financial instrument that reflects the movements of the asset's price underlying it. It allows for profits or losses to be realized when the underlying asset's price changes in relation to the position taken, but the actual underlying asset is never owned. Essentially, it is a bet between the client and the broker.

How a CFD Works
If an asset has an ask price of $10.00 and 100 units are bought at this price, the cost of the transaction is $1,000. With a traditional broker, using a 50% margin, the trade would require at least a $1,000 cash outlay from the trader. With a CFD broker, often only a 5% margin is required, so this trade can be entered for a cash outlay of only $50.00/

It should be noted that when a CFD trade is entered, the position will show a loss equal to the size of the spread. So if the spread is 5 cents with the CFD broker, the unit will need to appreciate 5 cents for the position to be at a break-even price. If you owned the stock outright, you would be seeing a 5-cent gain, yet you would have paid a commission and have a larger capital outlay. Herein lies the trade-off.
f the underlying stock were to continue to appreciate and the stock reached a bid price of $10.50, the owned stock can be sold for a $50 gain or $50/$1000=5% profit. At the point the underlying stock is at $10.50, the CFD bid price may only be $10.48. Since the trader must exit the CFD trade at the bid price, and the spread in the CFD is likely larger than it is in the actual stock market, a few cents in profit are likely to be given up. Therefore, the CFD gain is an estimated $48 or $48/$100.00=48% return on investment. The CFD may also require the trader to buy at a higher initial price, $10.28 for example. Even so, the $46 to $48 is a real profit from the CFD, where as the $50 profit from owning the stock does not account for commissions or other fees. In this case, it is likely the CFD put more money in the trader's pocket.