A contract for difference – also known as CFDs – is an agreement between two parties on the value of an asset, which will vary depending on how its price moves.
Where can CFDs be applied?
A CFD can be applied to nearly any type of asset. These include currencies, indices and commodities such as oil or gold. It’s important to realise that while there are no limits to what can be traded through a CFD, this type of product does not involve the delivery of tangible underlying assets.
Where can you get CFDs?
Companies that offer CFDs range from stockbrokers (you can check here), some large banks and several online brokers. As with most financial products, these institutions usually charge commission every time you enter into one of these contracts (also called ‘opening position’). Additionally, there might be other costs, such as a spread, representing the difference between the ‘buy’ and ‘sell’ quotes.
In many countries, CFDs are considered derivatives, meaning that their prices depend on an underlying asset. In this case, the product is based on a reference index.
As you can see, trading these instruments involves risk because they are leveraged products. It means you can control large amounts of money with only a small initial investment (called margin). However, if your position moves against you (if its value falls), you must pay more money to your broker to maintain it. So, if the market moves rapidly or unexpectedly, losses can mount up very quickly.
CFDs are not suitable for all investors, and you should fully understand the risks involved before trading.
What are CFDs?
So, what are CFDs? In a nutshell, they are contracts that allow you to bet on the future price movement of an asset. You don’t have to own the underlying security to trade a CFD – you can speculate on whether its value will rise or fall.
CFDs are considered derivatives because their prices depend on an underlying asset (in this case, a reference index). This means that when you buy a CFD, you’re essentially making a bet on how that index will perform.
There is no limit to what can be traded through a CFD, but keep in mind that losses can mount up quickly if the market moves against you because they are leveraged products. CFDs are not suitable for all investors, so please make sure you fully understand the risks involved before trading.
How are CFDs traded?
Now that we know what a CFD is, let’s take a look at how they’re traded
You agree with another person when you buy a CFD (your counterparty). You’re essentially betting on whether the asset price will go up or down.
CFDs are usually bought and sold over-the-counter (OTC), which means there’s no centralised price. It means that the broker sets the price, weighted according to their buy and sell orders. In this case, your position will change as you follow the prices of underlying assets. You can also close a position at any time in consequence.
To trade a CFD, you’ll usually need to deposit a margin, which acts as a security for your counterparty if your position drops below a certain level (called the maintenance margin).
If your trade moves against you, you may have to deposit more margin to keep it open. This is known as a margin call. If you can’t meet the requirement, your counterparty will close the position at the current price.
When it comes to trading CFDs, there are several fees and costs to consider
- Firstly, a commission is charged every time you enter into a new contract.
- Additionally, your counterparty may charge a spread. This represents the difference between the buy and sells quotes for each contract. It’s usually expressed in pence, but some brokers require them multiplied by 10 (a £1 spread would become £10).
- Finally, your broker may also levy other charges such as rollover interest or overnight financing. These represent additional costs that can affect your position.