Contract For Difference (CFD)

A Contract for Difference (CFD) is a financial instrument that allows traders to speculate on the price movement of various assets, such as stocks, commodities, indices, or currencies without owning the underlying asset.

When trading CFDs, you enter into an agreement (contract) with the broker, to exchange the difference in the price of the asset’s price from the time you open the trade to the time you close it. With CFD trading, you don't buy or sell the underlying asset. Instead, you buy or sell a number of units for a particular financial instrument​, depending on whether you think prices will go up or down.

If you think that the price of an asset will rise, you would open a long (buy) position, profiting if the asset price rises in line with your expectations. If you think the price of an asset will fall, you would open a short (sell) position, profiting if it falls in line with your prediction.

If the closing trade price is higher than the opening price, then the seller will pay the buyer the difference, and that will be the buyer’s profit, and if the price decreases, the seller profits.

The main benefits of trading CFDs are:

• Leverage – allows you to control a larger position with a smaller initial capital outlay;
• An access to various markets – CFDs offer a wide range of instruments you can trade, including stocks, indices, commodities, currencies, and cryptocurrencies;
• Long and short positions – you can profit from both rising and falling markets. Going long allows you to benefit from an upward price movement while going short enables you to profit from a downward price movement. This offers even more opportunities to profit.
• Lower costs – CFDs do not involve ownership of the underlying asset which simplifies the trading process and allows you to avoid costs associated with traditional trading, such as stamp duty or brokerage fees.

The main CFD risks include weak industry regulation, potential lack of liquidity, and the need to maintain an adequate margin.

In general, CFDs can be invested for the long-term, or traded for the short term, although the latter is a far easier goal to accomplish successfully. For example, you can open and close a position in a matter of minutes, so you can make gains from even short term market fluctuations. Because you’re trading on margin, your initial capital can be significantly small but your potential losses can be greater than your initial deposit. So in the end you still get all the benefits and risks of owning a security without actually owning it.