The Basics of CFD (Contract for Difference) Trading

By Stock Research Pro • October 8th, 2009

A contract for difference or “CFD” is a tradable instrument and a contract between two parties, a “buyer” and a “seller”, to document that the seller will pay the buyer the difference between an asset’s current value and the value of the asset at the time of the contract. If the difference is negative at contract time, the buyer pays the difference to the seller. A CFD mirrors the changes in its underlying asset (which is never actually owned), allowing for profits or losses to be realized as the asset price changes in relation to the position taken by the participant.

The Benefits of CFDs

CFDs have become a popular instrument in trading practices in recent years because they allow for both a speculative profit and a hedge against unprofitable investments. Advantages of CFDs include:

Minimal commission and margin requirements: CFD operations can be executed without the need to deposit an amount that covers the entire sum of the contract- typically less than 10% is required.

No Borrowing Stock or Short-Selling Rules: While some markets have rules that require the trader to borrow the instrument prior to shorting and may prohibit shorting at certain times the CFD market generally has no such rules.

Global Market Access: Most CFD brokers enable trading of any market (during open hours for that market) by offering products from all of the major markets around the world.

Multiple Trading Options: CFDs are offered for stocks, currencies, commodities and more.

The Downside to CFDs

One of the primary risks in CFD trading is in the lack of regulation of the market. Traders should thoroughly investigate a CFD broker before conducting business with them. Investors should also pay close attention to the spreads they have to pay and the impact on potential profits.

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.


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