CFD (Contract for Difference)

Examples of CFD

CFD (Contract for Difference) is primarily a tool that allows you to «derive» profit (hence the term «derivatives») from changes in the price of an underlying asset, no matter whether the price rises or falls. The underlying asset in question may be shares, bonds, futures, currencies, commodities, etc. Essentially, CFD is a kind of copy, or «clone» of the underlying asset. It is an agreement between two parties to exchange the difference between the sell and buy price of a contract, multiplied by the quantity of units of the underlying asset as stipulated in the contract. This instrument is a product of the «Over-the-Counter» (OTC) market.

Who should be interested in CFD trading in the first place and what are the advantages of CFD trading?

Why did CFD contracts emerge if it is possible to trade in the underlying asset directly? The main objective and advantage of CFD is that it provides traders with the opportunity to derive profit from changes in the price of an underlying asset while not directly «possessing» that asset. It does this by lifting some of the regulatory restrictions (mainly stemming from the amount of deposits required) on directly operating in the underlying market. Hence, with CFD dealing, a trader is able to obtain the same financial result they would as if dealing on the underlying market directly. Hence for beginner traders CFD is a crucial tool that will allow them to start electronic trading in underlying assets with a relatively low deposit at a correspondingly low risk, yet still with real money (a very important factor in preparing psychologically for trading).

CFD allows a trader to take long or short positions on an asset and also the underlying contract. The relative ease with which it is possible to take long or short positions broadens significantly the investment capabilities of a trader, who can now derive profit from both a price rise and fall. For example, to open a position per a futures gold contract on the New York Stock Exchange, it is necessary to have at least 5,000 US dollars (the so-called «initial margin»). What should a trader do who analyzes the market and would like to capitalize on his knowledge, but does not have the available funds to do so (i.e. wants to start trading in gold)? It is exactly this trader for whom CFD trading will prove useful because trading CFDs is based on margin, i.e. to conduct a transaction it is sufficient to have on average only 5 to 10 percent of the full contract value. The chance to operate not only through entire lots but also fractional lots (up to one tenth of a standard lot), reduces capital requirements for trading in the underlying market by a factor of 10.

In summary, the main objective of CFD is to meet the demands of customers with a relatively low deposit who would like to trade in capital intensive markets.