Contract for difference CFD

In Finance, a contract for difference (CFD), which is a financial derivative, has been widely used in trading Foreign Exchange (Forex) as well as other financial products, such as Indices, shares and commodities. CFD was invented in early 1990s in London for trading Equity Swaps. Then CFD was first introduced to retail traders in the late of 1990s. The first few companies were doing CFD are MF Global, IG Markets and CMC Markets.

It is a contract between two parties, normally called as buyer and seller; the buyer will be allowed to go long and go short as well, the buyer will pay to the seller the difference between the current value of an asset and the value in the contract time if the buyer made the wrong decision. Otherwise, the buyer receives money from the seller. CFDs are currently available in the following countries: UK, Hong Kong, Netherlands, Poland, Portugal, Germany, Switzerland, Italy, Singapore, South Africa, Australia, Canada, New Zealand, Sweden, Norway, France, Ireland, Japan and Spain. Due to the restrictions on over the counter (OTC) by US SEC, CFD is not available in US.

Most of CFD provider provided leverage within the CFD trading, so the users can modify the leverage in order to control their risk. CFDs do not have an expiry date and a daily commission charge will be applied to the account for long positions opened overnight. For short position overnight, it will attract an interest rate rebate. Therefore, there will no charges for all traders opened and closed within the same day.

CFD positions are normally quoted in the currency of the market you are trading. Thus, for example, your position will be valued in dollars if you open a long Gold CFD. It will create the inherent risk from dollars. When dollar is falling, your profits will reduce or your losses will be magnified.

The advantages of CFD have been listed as following:

  • Can go long and short as well

  • No stamp duty

  • One account can trade multiple financial products

  • Trading on margin, you can use your trading capital maximally

  • Good and useful trader tools to control your risk (such as stop losses and limit orders)

The disadvantages of CFD have been listed as below:

  • Leverage is a double-edged sword, you can maximize your trading capital but you could lose more as well

  • As you need to pay a commission charge for holding position overnight, you may find more beneficial to have bought the underlying asset to a long term trader

  • The CFD investor has no right as normal investor, such as voting rights

Simple example: Long Trade

Company ABC share current price is $10.30 - $10.50 and investor A believes that ABC is going to rise and places a trader to buy 10,000 shares as a CFD at $10.50. The total value of the contract would be $105,000 and they would only need to pay a 10% deposit as initial margin $1,050. The commission on the trade is $105 ($105,000 x 0.1%), stamp duty is 0.

Let say the share is growing up to $10.80 - $11.00 at the end of the trading day and the investor A decided to close the position. By selling 10,000 ABC CFDs at $10.80, the commission is $108 ($108,000 x 0.1%). The summary is shown as following:

Opening level     $10.5

Closing level      $10.8

Difference         $0.3

Profit                3,000 ($0.3 x 10,000)

Commissions       - $213 ($105 + $108)

Overall Profit   $2787

Some good video about CFD:

This is from City Index:

This is from Contract-For-Difference on Youtube:

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