Want To Know About Contracts For Difference

CFD stands for Contract for Difference, a Contract for Difference is a type of derivative exchanged between two parties, the buyer and the seller. The seller of a CFD has an obligation to pay the difference between the market price of a share or other instrument over which the CFD is based and the price of the contract when it was sold to the buyer. If the difference is negative, the buyer pays the difference to the seller.

Contract for Difference trading started in London in the 1990s. It was in the year 2001 that investors realized that Contracts for Difference had significant advantages over ordinary share trading, the main benefit was the avoidance of stamp duty.

CFDs have a number of benefits over ordinary share trading. The main benefit is that no CFD expires and the holder of a Contract for Difference is required to maintain a minimum margin amount, much less than buying stocks or futures contracts outright. For an individual to ensure that they earn money through Contract for Difference trading, it is essential that they calculate risk, study market trends on a frequent basis and avoid margin calls which can occur should the CFD position move against the buyer. Investors can go short or long and use stop loss orders allowing them to minimize their losses.

There are many types of financial instruments available allowing traders to invest their money in order to profit. Depending on the level of knowledge an investor has they will choose the right financial product to suit their needs. If we compare all types of financial instruments, then it can be said that CFD trading is most similar to futures trading with the additional benefit of liquidity and leverage.

Below are four of the main benefits of Contracts for Difference for short term traders

1. Overnight financing
CFDs are the ideal choice for short term day traders and there are a few key reasons for this. Firstly, CFDs incur a financing rate when you hold a position overnight. The financing for long positions is typically the Reserve Bank rate or cash rate. So if the Reserve Bank rate is 4.25% then you pay 6.25% per year calculated back as a daily rate as the Contract for Difference provider will add a haircut of around 2% on top of the Reserve Bank rate. You can avoid financing charges by closing your position before the day is over.

2. CFD Leverage
Another reason that CFD trading strategies are so common is leverage. If you had $5,000 in a stock trading account then you could only trade $5,000 and a 5% move on $5,000 would only be $250. If you took that same $5,000, invested in CFDs and opened a $20,000 position, that same 5% move now equates to $1,000. Thus with Contracts for Difference you can potentially make another $750 with no extra outlay .

3. Liquidity
The key for short term day traders is liquidity, unlike other derivative products such as options, Contracts for Difference reflect the liquidity in the underlying exchange. When trading using a Direct Market Access provider you can see the exact volume available on each stock CFD at each price level in the market depth.

4. Low brokerage
A significant advantage of CFDs for investors are their low commission rates. Some brokerage products such as index Contracts for Difference are commission free. If you are trading the top 300 ASX Contracts for Difference, the commission rate is still low. Typically brokerage providers charge a minimum of $10 or 0.1%.

If you want to learn more about Contracts for Difference you can visit our CFD page and you will find a host of related trading facts. You can learn more about Contract for Difference trading by visiting International Capital Markets website.