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Contracts for Difference (CFD)

 

 

Among the financial instruments available online through specialised brokers, contracts for difference, or CFDs, allow for a great flexibility by combining several advantages including the possibility of trading on the rise and the fall by using a leverage effect.

 

 

What is a Contract for Difference?

In the world of finance, CFDs, or Contracts for Difference, are a form of contract that links a buyer and seller. The buyer can make profits equalling the difference between the asset price at the moment of subscription and the price at the moment of reselling.

When the difference between the starting point and closing point is negative, it is the seller that gains the amount obtained, and the buyer is the loser.

CFDs are financial derived instruments that enable you to make profits, on the rise or fall of the price, through speculating on the movements in the price of an underlying asset. This asset may be in various forms such as currencies, shares, indices or even commodities.

 

The operation of contracts for difference:

As you have probably understood, a CFD is a contract completed between two investors that exchange the amount of the difference between the opening rate and the closing rate of a given asset. Previously reserved for investment professionals, CFDs have been simplified and made accessible to all by the online brokers that enable all investors to use them without requiring any great knowledge of trading.

CFDs generally offer a leverage effect that can go up to 1:20 according to the asset traded. In fact, the most volatile assets have a lower leverage effect than the less volatile assets due to potential profits, but also the risk level incurred. Due to this leverage effect you can make larger profits with a minimum capital.

As previously explained, Contracts for Difference enable the speculation on the rise and on the fall according to the position you take as a buyer or seller on the market. When you sell a CFD, this is basically a speculation on a fall in the asset price, and when you buy a CFD that represents a speculation on the rise in the asset price.

 

Fees and functions of Contracts for Difference:

When you trade CFDs online, you need to take into account the fees charged by your broker which are included in the spread, that is the difference between the best buying price and the best selling price. There again, these spreads vary from one asset to another, as well as between one trading platform and another.

However you also need to check the fees invoiced by certain brokers when you keep your position open over the long term, particularly at the market closing times.

As in the case of Forex trading, CFDs offer various trading tools such as stop and limit orders that enable you to minimise the possible risks and close your positions at the best time.