What are Contracts For Difference?
Contracts for Difference or CFDs are a financial product in which two parts exchange the difference between the buy/sale price in a financial transaction. The CFDs are one of the most interesting financial products from the point of view of an alternative investment for the Stock Market, since we can perform the same operations we normally do in this financial market, but being more efficient in managing our capital investment
As mentioned before, this contract involves two parts:
- The investor: Is the one who gives the order to buy or sell a contract of certain underlying instrument or asset (shares, indices, commodities, foreign exchange and many others).
- The issuer of the CFD: Is the one that issues the Contract for Difference and is usually a financial institution or broker-dealer, who is in charge of the operation of buying and selling that that is directly associated to this product.
Basically, in this financial product the liquidation is made for differences between the purchase price (sale) and the sale price (purchase), for that reason there is no need to deliver the asset traded. This is because the issuer is funding the liquidation and requests the investor only a small part of the transaction nominal as security.
Types of Contracts For Difference
The different types of Contracts For Difference differ in the underlying assets of each contract. The main types of CFD are:
- Contracts For Difference on stocks.
- Contracts For Difference on commodities.
- Contracts For Difference on foreign exchange.
- Contracts For Difference on indices.
- Contracts For Difference on bonds.
Advantages of Contracts For Difference
The main advantages of CFDs are shown below:
- The Contracts for Difference are a leveraged product: This means that to invest in an asset such as stocks and commodities using CFD, the investor will pay only a percentage of the total value of purchase. In other words, in the time of investment, the trader does not have to invest the total price of the underlying asset of the contract, but only a portion of it as a guarantee. Depending of the broker, this guarantee could be 5% to 25%.This also means that the investor needs to invest less money to get the same gains he would get by trading directly with the underlying products such as stocks, commodities or other. Thanks to this, the necessary capital to invest with CFD is lower than the needed capital to invest in other financial instruments.
- With the investment through Contracts For Differences, the investor can benefit with increases and decreases in market. Thus, depending on whether you have long or short position, you can take advantage of the total of decreases or increases in the market, with a much lower investment, as we explained.
- The CFD allow the immediacy of the liquidation of the benefits from the transaction.
- Contracts For Difference provide the ability to trade 24 hours a day. This allows the investor to avoid unpleasant surprises occur before the opening of financial markets. Also avoid the limitation imposed by stock exchanges that operate only a few hours a day.
- Contracts For Difference include the ability to use stop loss orders as a protection against losses that may be taken.
- The transparency offered by the Contracts For Differences, prevents the broker can enter hidden fees. Typically, the fees charged for transactions in CFD on shares are usually fixed (between 0.8% and 1% in most cases).This allows to know in advance the cost of transactions, avoiding brokerage fees, custody and maintenance, among other charges.
In subsequent articles we will interiorizing more on the subject and seeing other features and advantages of this financial product that has become so popular in recent years. In the following table we display a list of Forex brokers which allow transactions with Contracts For Difference:
List of CFD Brokers
|Broker||Type of broker*||Minimum Account deposit||Broker Review|
|XM||Non Dealing Desk||$5|
|Hy Markets||Market Maker||$50|
|Admiral Markets||Non Dealing Desk||$50|
|Neto Trade||Non Dealing Desk||$100|
|ETX Capital||Market Maker||$100|
|Forex Club||Non Dealing Desk||$200|
|Financial Spreads||Financial spread betting&CFD||$100|
*NDD: Non Dealing Desk
ECN: Electronic Communication Network