Contract for Difference (CFD) is an agreement made by both the investor and the brokerage firm. In the agreement, it states that at the end of the contract, one party will have to pay the difference between the value when the contract ends and the value of the security when the contract starts. If the market moves according to your prediction, you can get the profit out of the price difference. But when your prediction is incorrect, the broker will get benefitted as the difference will get deducted from your account balance.
Brief History of CFD
What is CFD trading? Is it the same as Forex trading? Contract for Difference was previously for financial institutions like banks only. But after some time, it has become available for retail investors and traders since it allows trading without having to own any securities. There are a lot of novice investors nowadays that are interested in trading CFD.
It became more and more popular over the years and CFD has been subjected to numerous security purposes to protect the traders from scammers and illegal activities. In fact, last October 2017, Euromoney reported about the staunch defense launched by CFD trading services.
Facts About Contract For Difference
Just as its name suggests, CFD is a contract between traders and brokers. Similar to stocks, CFD is also being traded on an exchange. The big difference is that when you trade CFD, you don’t really own the asset. When it comes to the expiry date, CFD doesn’t have an expiry, unlike futures and options. CFD is being renewed every time the trading day closes and you can then roll it again if you want. Traders have the option to keep their positions open whenever they like as long as they have enough margin on their trading account that can support their open positions. As the contract remains to be open, the provider’s account is credited or debited so as to reflect the interest or the dividend acquired.
Only a few charges are taken from you when you trade CFD. Moreover, quite a lot of brokers also refuse to charge fees and commissions of all sorts whenever a trade is entered or exited. The only way that brokers get benefitted is when traders pay for the spread. When you buy, the trader will have to pay the asking price. To sell, the trader will have to take the bid price.
For instance, you are an investor and you have noticed that Omnicorp, an up and coming tech company, is thriving in recent days. You predict that the shares of this company will go up. How should you profit from the price movement? Let’s just say that you’ve bought a lot of shares of Omnicorp and you are waiting for its price to reach its peak. But is it all worth it? What will happen if the price rise turns out to just be minimal?
Another option that you can take is to buy CFD on the share and go on for a long position. If the price of your shares goes up according to what you have predicted, then you can get the difference between the opening and closing of prices.