Contracts for differences (CFDs) are contracts between a buyer (investor) and a seller (which can be a financial institution such as an investment bank or a spread betting organization).
Usually, investors analyze and speculate on price movements and make trades based on forecasted values of the particular assets.
CFDs are usually short-term contracts. The agreement made is that when the contract ends, the buyer and seller exchange the differences between the opening and closing trade prices. The contracts are settled in cash rather than physical goods, products, or securities.
One of the biggest advantages of CFDs is that it allows traders to benefit from price movements without owning a single underlying asset. In essence, contracts for differences are a trading strategy. They are a form of derivative trading. A derivative gets its value from the performance of the underlying assets.
How Do CFDs Work?
For a CFD to work, there needs to be a buyer and a seller. These two will come into a contract to exchange the differences in the value of a financial product. The buyer does not own any of the underlying assets but is a beneficiary of the revenue generated from the price movements of the underlying asset.
For example, an investor can simply speculate on price movements of an asset without actually buying or selling the particular asset (e.g. shares). So the speculation is based on the future value of an asset (e.g. shares). The advantage is that these speculations aren’t limited to upward movements, they can also downward price movements as well.
CFD trading is in a sense, a gamble. Studying charts and other forms of data cannot accurately predict how the values of shares will change. This is why CFD trading is usually not recommended for rookies or newbies. Statistics show that almost 76% of retail investors lose their money.
Why trade CFDs?
Despite the tremendous risks involved, there are many reasons for investors to consider CFD trading.
One major reason is that CFDs are derivatives. This essentially means that traders can speculate on price movements derived from the underlying markets. This means that traders don’t need to own an asset to trade CFDs
Because of their many benefits, CFDs are a popular form of trading. Some of their useful benefits include;
- Using leverage can make investment capital go further.
- Traders can opt to go short or long.
- There is a wide range of instruments that CFDs can be traded on.
- It can be used to hedge a share portfolio
- Traders have access to global markets
- Contracts are usually settled in cash
Let’s take a closer look at some of these benefits.
Benefits Of Contracts For Differences
Unfortunately, CFDs are banned in some countries. But in the countries where CFD trading is permitted, there is a myriad of benefits that come along with it.
- 24hr Global Access
CFD investors trade through a broker. The vast majority of these brokers, provide products and services on major markets globally. This means that traders aren’t limited to local markets. This in itself comes with benefits of its own. For instance, global markets can be accessed around the clock. This means that traders can trade from anywhere in the world and at any time.
- Professional Services Through Brokers
CFDs, like other forms of trading, are traded through brokers. This means that traders have access to professional help and service. Some services include; limits and stops which are essential tools for investors. Most brokerage firms offer these services at no extra cost.
CFD investors usually don’t own any of the underlying assets. This means that they can enjoy tremendous benefits that come from the value of the underlying assets. They are also able to partake of huge risks, without actually risking their assets, because they don’t own any. CFD contracts are settled in cash rather than physical products.
Wrapping It Up
As a newbie, it is wise to spend a good amount of time researching and studying a wide number of resources. This helps create and widen the knowledge base which potentially makes an investor a good trader. After getting some good information, take time to practice. A demo account (usually provided for free on most brokerage firms) will help provide the practice needed. It uses virtual money to trade in real scenarios. This is a great way to learn from mistakes. It also helps traders understand the ins and outs of CFD trading.