What are contracts for differences? (CFDs)

contracts for differences

Contracts for differences or CFDs for short represent the contracts between the investor and the broker. These contracts allow the investors to trade the difference in the value of an underlying asset between the beginning and the end of that contract. These usually last for a full day.

CFDs allow the investors to speculate on the rise or fall of the particular prices in various different financial markets, such as the stock market, Forex market, commodity markets, cryptocurrency markets, and others. By speculating on the potential price actions (shorting or longing a particular asset), the investors don’t have to make an actual purchase of the stock/commodity/currency. Instead, they use the above-mentioned CFDs to finalize their bets and trade on the derivatives of those assets.

What assets can be traded using CFDs?

CFDs allow investors to invest in various different types of assets, including commodities, indices, cryptocurrencies, traditional currencies, the Forex market, company stocks, and many more. Since CFDs represent trading on the derivatives of those assets, they are often traded on margins as well.

CFDs with long, short, and margin trading

The speculative nature of CFD trading allows investors to bet not only on the rise, but also on the fall of the price of a particular stock, currency, or commodity. While long trading represents betting on the upward moving momentum of the asset or believing that the particular asset will rise in its price, investors also have an option to short or margin trade.

Shorting an asset involves betting on the downwards price action of a particular asset. This means that CFDs allow investors to profit from the falling market because they believe a certain asset will fall in its value.

Last, but not least, margin trading, often referred to as leveraged trading, includes two different types while trading with CFDs: 1) the amount required to open a position, also known as deposit margin; 2) maintenance margin, which may be required if the position starts collecting losses that can not be covered using the deposit margin (or additional funds being held in the investors’ account)

Trading with CFDs or trading with shares?

As we already said, trading with CFDs offers the investors a possibility to trade using simple derivatives of an asset of their choice, without having to actually purchase the asset itself. This is the key difference when it comes to comparing CFD trading with shares trading. Investors who trade using CFDs practically just speculate on the price movements of the assets they’ve picked, which can be either betting on the upwards or downwards trend of the price chart. That being said, trading with CFDs definitely looks like a way more flexible trading option than purchasing the actual shares.

Another important thing to mention is that trading with CFDs includes the ability to make leveraged trades. Since CFDs can be traded on a margin, the investor has a possibility to open bigger investment positions, which are relative to the amount of their initial capital.

Besides these main differences, there also are many other differences when comparing the CFDs trades, to traditional trading with shares. One of the most prominent differences includes the fact that trading with CFDs offers investors to trade at any given time, and on various different markets, while traders who trade using shares are able to trade only during the stock market working hours.

Criticism of CFD trading

Many different financial experts often criticize and point out the negative properties of CFD trading. One of their main concerns includes the overly pompous ways that CFDs are being marketed to new, inexperienced investors by numerous CFD providers. This in particular includes overmarketing the potential profits, while not fully explaining the risks involved in CFD trading.

Besides that, many financial experts believe that most investors actually lose money using CFD trading. Although it is not possible to confirm if this statement is true, because CFD providers do not publically provide this information, the prices of CFDs are usually based on publicly available instruments. If we take those into consideration, odds are definitely not stacked against traders, since CFDs are simply the difference in the underlying price.

Experts also point out the lack of transparency in CFD trading, as it mostly happens over-the-counter, and typically includes no standard contract. Criticism was also expressed on the fact that many CFD providers hedge their own exposure, causing a conflict of interest while defining the terms under which those CFDs are traded.

CFD trading summarized

While trading with CFDs offers many benefits when compared to traditional types of trading, like trading with different stocks, it also certainly offers an increased risk while engaging in the trades. New investors should be particularly careful while they start to make their first CFD trades. Some of the above-mentioned risks include the volatility and instability of leveraged trading, which are, according to many financial experts, often not communicated well enough by the CFD providers.

On the other hand, if an investor chooses to invest responsibly and based on their own research and due diligence, CFD trading can offer a wide range of trading possibilities and benefits, especially when being compared to the traditional purchases of stocks. From long and short positions to margin trading, CFD trading utilizes many possibilities which can potentially amplify your profits, all while making your bets without having to actually purchase an asset.

As always, we advise you to invest responsibly. You should never invest the money you can not afford to lose, especially since with CFDs you’re betting on the price action and not actually purchasing a certain asset.

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