Contracts for Difference: Structure and Characteristics
This lesson defines the contract for difference, describes the exposure it provides, and sets out the characteristics that distinguish it from ownership of the underlying asset.
Risk note: educational content only. This article is not financial advice, investment advice, or a recommendation to buy or sell any instrument. Trading leveraged products can result in losses greater than expected, and each reader should understand the risks before trading.
The instruments traded at Onys Kapital are contracts for difference, commonly abbreviated to CFDs. A CFD is a straightforward instrument in its construction, but its characteristics have consequences for risk, cost and counterparty relationships that are not always apparent to a new participant. This lesson defines the contract, explains the advantages it offers in terms of market access and directional flexibility, identifies the risks that arise from its leveraged and derivative nature, and describes the contractual relationship between the client and the broker that governs every transaction.
Definition and settlement
A contract for difference is an agreement between two parties to exchange the difference in the price of an underlying asset between the time the contract is opened and the time it is closed. If a trader holds a long position in one contract on gold and the price rises by USD 20 per ounce over the life of the position, the trader receives the monetary value of that USD 20 movement multiplied by the contract size. If the price falls by the same amount, the trader pays it.
The contract confers exposure to the price of the underlying asset and nothing further. No physical gold is held on the client's behalf, no share certificate is issued and there is no dividend entitlement in the ordinary sense, although cash adjustments reflecting corporate actions may be applied to equity CFDs. The trader's financial result is determined entirely by the change in price between opening and closing, adjusted for the transaction costs described in Lesson 6.
Market access and directional flexibility
The derivative nature of the contract makes markets accessible that would otherwise require multiple accounts, custodial arrangements or substantial capital. A single account denominated in one currency can hold positions on an equity index, on crude oil, on a share listed on a foreign exchange and on a currency pair. Contract specifications are set by the broker and published on the trading conditions page and within the MetaTrader 5 platform.
A CFD also permits a short position to be opened as readily as a long one. Selling an asset that is not owned ordinarily requires a borrowing arrangement and the payment of a borrowing fee; with a CFD, a sell order simply establishes a contract that gains value as the underlying price falls. This symmetry allows a trader to express a view in either direction without additional administrative steps.
Risks arising from the structure of the contract
CFDs are traded with leverage as a standard feature, and leverage magnifies gains and losses in equal proportion. The exposure carried by a position is substantially larger than the margin deposited to support it, and a movement against the position produces a loss measured on the full exposure rather than on the margin. Where the market moves sharply between one price and the next, as may occur over a weekend or at the release of unexpected news, a stop-loss order may be executed at a level materially worse than the level specified.
The ease with which positions may be opened and closed also introduces a behavioural risk. Because a transaction requires only a single instruction on the platform, the friction that would otherwise discourage excessive activity is absent, and the accumulation of transaction costs through overtrading is a common cause of loss. Positions held past the daily rollover are subject to overnight financing unless the account is designated swap-free.
- The exposure of a position substantially exceeds the margin deposited against it.
- Positions held past rollover incur an overnight financing adjustment unless a swap-free account is used.
- A price gap may result in a stop-loss order being executed beyond the specified level.
The broker as counterparty
A CFD is a contract between the client and the broker. The broker is the counterparty to every position, and the financial standing, regulatory status and operational practices of that counterparty therefore form part of the client's risk. Onys Kapital Ltd is a Securities Dealer Licensee regulated by the Financial Services Authority of Seychelles under licence SD128. Regulatory supervision, the segregation of client funds and the quality of order execution are of greater practical significance to a client than the presentation of the trading interface.
The terms governing the relationship are set out in the Client Service Agreement. This document defines the obligations of each party, the treatment of margin, the procedure for closing positions when margin is insufficient and the handling of client funds. Clients are advised to read the agreement in full before trading, since it is the document that governs every transaction conducted on the account.