A Contract for Difference, commonly known as CFD, is among a list of very popular ways to increase returns in the financial markets. Just as the name suggests, it’s a contract executed between two parties. These two counterparties – the broker and the client, agree to pay or receive from each other the difference between the shifts in the value of an asset. How much each pays or earns is entirely dependent on the direction the price takes and the extent it moves.
CFDs and Stocks Explained
In financial terms, CFDs are usually referred to as financial markets derivatives. When the value of something is derived from something else, it becomes a derivative. In this case, CFDs are derived from the value of another financial asset such as stocks or shares. Although there are other assets such as foreign exchange rates and interest rates, a large portion of CFDs are based on stocks.
Through a CFD, you can trade an underlying asset such as stocks without really buying it. You never own the asset. However, you’ll be making either profits or losses depending on the movement of the prices. When entering into a CFD, you’ll take a position of whether or not the stock will rise or fall within a certain amount of time. If you expect the stock to rise, you’ll create the CFD with a CFD broker, in addition to a small fee, and once your prediction turns out to be correct, you earn a profit.
For many people, a CFD can be an advantage as you never own the actual stock, which brings higher costs, yet you still benefit as the security rises in value. One of the ways stockbrokers earn money is by charging commission to investors for every buy and sell order. A CFD charges commission that’s usually within .25 to 5 percent of the security purchased. These prices are usually lower than what you would pay a broker to buy the actual stock.
Why do a CFD instead of buying stocks?
When buying stocks, you’ll have to pay 100% of the total value at the time of making the purchase. But when you opt for a CFD you’ll only have to deposit with the broker enough money to cover up your potential losses. This is normally a small percentage based on the value of the asset in question. It could be as low as 2%. That actually implies less capital outlay for you as an investor yet greater potential of high returns.
The ability to trade after hours
Another benefit CFDs have is the ability to trade even after the markets have closed. There are CFD brokers that allow you to establish a contract after hours to make it more convenient. To limit losses, you would set a Stop Loss price that would automatically sell the CFD if the stock plunges the following day while at work. The implementation of proper risk management functions like this will allow you to stay on top of your account should things turn sour.
Easy trading options (Long or short)
As an investor, you can profit from a declining market by capitalizing on share price declines. Since CFD is based on the movement of prices of the underlying asset and no ownership is required, selling is pretty easy and so is buying. Initially, before CFDs came along, traditional brokers were the only ones who would help you if you short a share, and they would charge extra fees above the normal brokerage. Interestingly, for short CFD positions, a CFD broker will, in fact, pay your interest.
So to sum up, CFDs can be an interesting alternative to stocks. Looking at all these advantages, one can’t help but notice the many ways an investor can reap huge and enjoy a host of financial benefits using CFDs. Enlisting the services of a CFD broker can be more cost-effective than hiring a stockbroker.