A contract for difference (CFD) is a contract between a buyer (investor) and a seller (broker). The contract is an agreement between the parties, stipulating that the difference in the value of the assets during the contract period will be exchanged. In other words, the asset’s initial value and the value of the same, at the end of the contract, will be exchanged. When a profit is made, the seller pays the buyer but when it is a loss then the buyer needs to pay the seller. So in essence the buyer gains or losses the margins produced within the period the contract was open.
CFDs are remarkable especially when it comes to their many useful benefits. A major one is that it allows investors to trade underlying assets, without actually owning any. The only requirement is a small investment (a small percentage of the total asset value. Through this form of trade, investors can fully benefit from price movements.
At its core, CFD trading is defined as the exchange of CFDs. Payments are in cash since no physical goods are exchanged in CFD trading. This is because they are derivatives i.e. they get their value from underlying assets. Essentially, CFDs traders can speculate on price movements within a trading market, without owning any underlying assets themselves. As long as a premium (a small percentage of the total asset value) investors can trade CFDs.
Types Of CFDs
Many financial instruments can be traded on CFDs. Let’s take a looks at the different kinds of CFDs.
CFDs aren’t permitted in certain regions. For the regions that allow CFD trading, investors need to be keen on the different types of CFDs that brokers offer. Not all types operate in the same way which can be frustrating. This is why it is essential to understand the different financial instruments that can be used to trade CFDs. The trading asset defines the type of CFD traded
The main CFD market types include:
- Global Stock CFDs
These are CFDs whose underlying assets are stocks in the global market. Some examples include UK, USA, Asian and European
- Share CFDs
The most commonly traded contracts are share CFDs. The prices of these types of CFDs come from the price of the underlying stock. For experienced traders, this creates a similar feel as trading stocks.
- Index CFDs
These are CFDs whose underlying assets are stock indices. These types of CFDs derive their value from their underlying assets, i.e. indices. The performance of such a trade is therefore connected to price movements of the specific index.
They are particularly popular among traders because of their volatility, liquidity, and high leverage. Some examples of popular indices include; Dow Jones, Australian Stock Exchange, NASDAQ, London Stock Exchange, and Nikkei.
- Commodity CFDs
This is another popular form of CFD trading. It involves highly demanded physical assets. There are generally two categories of commodities i.e. hard and soft commodities.
Hard Commodities – This refers to commodities that are mined. Such items vary in terms of quality from one item to the next. For example, if gold is the mined substance, the pieces will not be of the same size or value.
Soft Commodities – This refers to commodities that are grown. In terms of quality, there usually isn’t much difference between the assets. Such items are referred to as fungible goods. An example would be peanuts. A single peanut will probably be the same as the next peanut.
Some of the common CFD commodities include; precious metals, corn, soya beans, wheat, gasoline, crude, and heating oil.
A unique aspect of CFD commodities is that a trader can use the underlying asset to trade futures while enjoying all the benefits of CFDs.
Trading commodities through CFDs is beneficial because it is less complicated than trading directly.
- Treasury CFDs
This is a form of trade that allows traders to speculate on price movements of treasury notes. Some of the commonly traded treasury notes include; US Bonds, Euro-Bond, and Australian Treasury Bonds.
CFD trading is a form of trade that has several benefits including the ability to trade on various financial markets. Investors should take time to study the market and even understand the different types of financial instruments available.