CFDWhat Is The Contract For Difference?
CFDs are the most successful financial instruments, which in recent years have become the favorite tool for all traders. This tremendous growth that has seen them beat other derivative instruments is due to three main features:
- They require reduced capital.
- Wideassortment of available assets.
- Simplicity and speed of use.
CFDs or Contracts for Difference are tradable online and allow you to benefit from the price changes of an underlying financial asset, which can be a share, currency exchange, commodity, ora combination of the 3.
Trading with CFDs is therefore a practice that allows you to make predictions about the performance of financial markets and profit in the event of a favorable outcome. Therefore, the CFD contract allows you to invest in securities that you DO NOT physicallyhave access to, through prediction or speculation on your part.
Let's take a look:
After noticing a sprouting rise in Apple's title, we expect the title to fall down in the following days, so I decide to open a trade with CFD: I select the asset apple, input an amount $50, choose the down direction, and click on open trade.
After 2 days I see my investment has a balance of $65 as the listing has dropped as I expected and with a click on close trade I decide to close the investment with a net gain of $15.
I invested a small amount, with a few steps, on the value of an action, which would take many complications and much more money to buy it.
Most CFDs have no expire date, so you are free to keep your position open as much as you want, but meeting the overnight costs, or the small percentage rewards that the broker is facing in exchange for maintaining the position overnight (3 nights in the weekend). Therefore, it is advisable to use these financial instruments to achieve results in a short time.
The benefits of Trading with CFD
Trading with CFD has many advantages, which we could summarize with a cheaper cost than traditional investments, but also practical and speed. With CFD you have the opportunity to negotiate online from your computer, smartphone or tablet, with many less bureaucratic practices that is required by traditional investment.
Often to invest on an asset there are minimum purchase limits and you have to buy the minimum lot or a fraction of it. With CFDs it is possible to invest on any asset, brokers these days usually allow trading with small amounts.
For example, holding paper titles deposited in a bank can only be traded after consultation and requests. CFDs can be negotiated in one click, and open positions can be closed in a few seconds, in a practical and fast way and only for short-term profit purposes. So you can also take advantage of an increase of a few minutes, then close the position and make a profit.
Another big advantage is that with CFD trading you can also profit from falling forecasts, which can’t be done with shares. To do this, you do not need to buy and then resell, but just open a "short sale" position.
What is the difference between CFDs and Shares?
Unlike stocks, trading with CFDs does not require shareholding, so there are not even the many bureaucratic practices and the costs that characterize a traditional equity investment, such as stamp duty or Management costs.
The shares of a listed company can only be acquired and earned only if its value increases. Trading CFDs on the other hand can benefit a trader from the rising value of the company's share, or the declining value. If we think that its value may decrease, we will open a downward position.
Another big difference between CFDs and shares is in the leverage. CFDs are leveraged instruments, so for each single transaction, the user will not be exposed for the total amount of the value of the shares traded, but for a greater or lesser percentage that he/she can set.
For example, a leverage of 1:20 allows you to negotiate on shares worth a value of 1000 euros with only 50 euros. Margin and leverage rates may vary depending on the broker and type of financial instrument used.
Lastly, while stocks provide substantial capital to acquire shares of various sectors and industries, due to theimposed minimum deposit, CFDs allow you to create a small equity portfolio of stock CFDs. This is achieved by choosing the components of thousands of shares around the world listed on all major stock markets.
the Analyst's answerJean Grossett - Financial analyst
Without physically owning commodities, currencies, treasuries, shares or indices, the CFDs allows any trader with an internet access the opportunity to speculate or hedge in these markets.
With CFDs traders have access to more global markets at a much lower cost, as well as timely ease of getting in and out of positions.traders find them very attractive for their ease of getting in and couple with its tax efficiency. What this means is that there are no stamp duties to pay, and also CFDs can be used to hedge physical security.
Unlike futures contract which are contract between two people to be deliver a product at a future date, with expiration time, CFDs are also contracts between buyers and sellers, without expiration time. It allows buyers and sellers take advantage of long and short positions, and a difference is paid to who so ever got the direction right, either buyer or seller.
CFDs are available in most countries in Europe, Asia and Australia with an exception of the U.S. and a few other countries. The U.S have strict rules on trading over the counter products, and CFDs can only be traded by regulated/registered exchanges of which no exchange offer CFDs in the U.S.
There are inherent risks in CFDs which include high leverages, liquidation risks through margin call, and counter party risk. It is the high leverages that attract a whole lot of new traders into CFDs, because they are mainly carried out on margined accounts. The leverage carries a very high risk, in that it allows a trader to take on huge positions with a very small deposit. As soon as there is a margin call a trader will be notified to make another deposit, of which if he doesn’t, his trade will be closed in a loss which he will have to bear. In a case of high volatility periods, a trader can even loose more than his set stop loss.
the Manager's answerRobert Danvil - Investment Manager
There are many conflicting opinions on sound of CFD , mostly criticism among financial commentators and regulatory bodies, on how CFDs are being pitched to newbie traders. They are mostly presented with more emphasis on the huge gains achievable without mentioning the inherent risks enough. The Financial Services Authority (FSA), a regulator in the U.K called for CFD operators to have the risks involved in CFD trading clearly set up on their web page.