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What Exactly is a CFD?

What exactly is a CFD?


CFD (CONTRACT FOR DIFFERENCE) TRADING INFO SHEET

Thanks to IFC Markets for providing much of the CFD information included here.

HISTORY OF CFDs

CFDs are relatively new.  They started being traded in the early 1990s as compared to futures (1730s) and options (1973).  CFDs were originated by a London derivative brokerage firm called Smith New Court which was ultimately acquired by Merrill Lynch.  Economists Brian Keelan and Jon Wood played a great role in the invention of CFDs.

Clients of New Court wanted to hedge their positions on the London Stock Exchange, and CFDs were perfect tools to do it by going short, as well as getting an opportunity to trade on margin.  CFDs also allowed avoiding Stamp Duty which is an added bonus.  Later on, CFDs were used not only by hedge funds, but also gained wide acceptance among retail traders.

Starting in 2002, exchanges in many countries of the world also opened their doors to this instrument.  The first was Australia.  CFD trading has made its appearance in exchanges of Germany, France, Norway, Italy, Singapore, etc.  Interest in trading CFDs continues to increase.  The volume of CFD trading is estimated about 25-30% of daily equity trades in the London Stock Exchange and 10-15% of the total transactions in the Australian Stock Exchange.


WHAT IS CFD?


CFD (Contract For Difference) is a derivative financial product, since its value is obtained through the value of another financial asset.  CFDs will allow you to trade on prices, buy or sell without physically possessing the underlying asset.  The UA in most cases is a stock, but there are also CFDs for Indices, Commodities and other instruments.

According to the traditional definition, CFD is a contract between two parties, a buyer and a seller.  If the difference between the price of an asset at the moment of opening a positon on CFD and its price at the moment of closing this position on CFD is positive, the seller pays to the buyer and, just on the flipside, if that difference is negative, the buyer pays the seller.

CFD trading is almost like Stock trading.  The primary difference is that while you trade Stock CFD you do not own that Stock, you just use the price fluctuations of that Stock in order to speculate.


WHAT IS ATTRACTIVE ABOUT THE CFD MARKET?

  1. Leverage:  If you compare the price movement of a CFD with that of a common stock, you will see that the Stock CFD moves in the same direction as the Stock itself.  The price of the CFD repeats the price dynamics of the Underlying Asset.  Then why do most people prefer trading CFDs?  The answer is quite simple- the advantage of Leverage, due to which you enhance your potential returns.  In the Stock Market an Apple stock’s price is $500, you pay the whole sum in order to enter the market (purchase a share).  In the CFD market, you need to pay only a small percentage of your trading capital.  This percentage depends on the stock type and on a CFD provider.  Some offer 1% margin, others 5-20%.  Example: you want to buy 1 share of Apple at the price of $500 and the margin of 10%.  This means we pay only $50 of the actual Stock price.

  2. Trade on both Rising and Falling Markets:  Any CFD trader can get an opportunity to make a profit regardless of the market direction as you trade the price dynamics of the underlying asset.  In the case of opening short positions, you do not have to wait for your stock broker to loan you the underlying asset which is not always possible or available.

  3. Dividend Payment:    Like Stock providers, CFD providers also pay dividends to traders on long positions.  So, dividend adjustment is credited to the client’s account in the case of going long, and is debited from his account in the case of going short.

  4. No Expiry Date:  Another key advantage of CFD trading over other derivative instruments (ie futures) is that you can trade them without any expiry date.  This means you can keep your positions open as long as you wish.  No limitations, restrictions, or time limits.

  5. Low Commission:  Commissions vary by provider but generally they can be as low as 0.1% of your investments.

  6. Access to International Markets: The rise of the internet has made it possible to get access to any market.  You can use all the opportunities of the American, Canadian, Asian, Australian, and European Stocks.  This varies by CFD Provider.


GUIDELINES TO CHOOSE YOUR CFD PROVIDER


If you use the following criteria to compare CFD providers you will end up with a choice that meets your needs: 

  1. The reliability of the provider (How long have they been in business?)

  2. The margin requirement level

  3. Service Charges

  4. Trading Platform

  5. The types of CFDs offered ( Markets and trading hours)

  6. Spreads (the difference between bid and ask prices)

  7. CFD Account opening procedure

  8. Withdrawal procedure

  9. Education, Training, Seminars available

  10. Risk Management Tools (Stop loss orders, Trailing Stops, etc)

  11. Customer Service (simply call them and see what response you get)


EXAMPLE OF A CFD TRADING DEAL


Going Long- Buy to Open 400 Facebook (FB) @ $200 ASK

In a regular Stock Broker Account you would need $80,000 USD in cash or margin to purchase 400 shares.   With a CFD Provider offering 5% Margin and commission of $0.02/share this is how the numbers would work:

Account Balance $80,000 x .05 = $4,000

Commission 400 x .02 = $8 (per transaction)


CFDs ARE NOT PERMITTED IN THE USA


It is interesting to point out that CFDs are not currently permitted to be traded by USA Residents due to restrictions by the Securities and Exchange Commission on over-the-counter financial instruments.  Over-the-counter instruments, such as CFDs, are heavily regulated through legislation like the Dodd Frank Act and enforced by SEC. This power was granted under Title Vii of the Act when CFDs were defined as either a swap or securities based swap.  There are currently no registered exchanges in the US that offer CFDs for trading.

Whether this ban will ever be lifted is open to debate.  Many experts believe that Strong Lobbyist Action is behind it to protect the highly lucrative Options Markets.  Almost all Major US Banks are involved in CFDs in their foreign offices and marketplaces.

U.S. Residents CAN trade CFDs through TradeNet as part of an education/training package.  This firm has obviously discovered and taken advantage of a Loophole in the SEC Regulations.  See Blake Anderson’s RLT video on his experience to date with the TradeNet TEFS Software and Order Entry System.  Your initial starting balance is your fee for the Training and allows you to open an Account with the Cypress Based CFD Trading Firm TEFS.

This is a pretty sweet feature as you have the ability to trade $80,000 of allocated funds with less than $3,000 of investment. Get more information here. 

If you plan on growing a small account, there are a few choices out there. Browse through this video. 

To learn how to trade both Forex and Futures with OPM (other peoples money) check out this video. 


NON US RESIDENTS CFD OPTIONS


A quick google search will bring up numerous CFD Providers.  Not all deal with Stock CFDs which is what I am most comfortable trading.  I have included a simple chart outlining the main differences between three CFD providers that I have personally used for trading Stock CFDs.


IFC Markets provides opportunities to trade the following instruments:

Currency Pairs

Precious Metals

Continuous Index CFDs

Stock CFDs

Continuous CFDs on Commodities

CFDs on Commodities Futures

Gold Instruments

CFDs on ETF

CFDs on Crypto Futures

You can even create your own Synthetic Instruments Library

 

I am currently trading a position size of 1,000 shares of AMD using IFC Markets.  This requires an account size of $1,200 to $1,600 USD depending on the share price.  The fixed spread on entry and exit orders is $0.02 and your limit orders must be $0.04 away from the current market price.  You can place trades directly from the chart including your stop and profit targets.


If you have any further questions, join the Real Life Trading Community and then reach out to me! You'll find me crushing AMD in the Day Trading Room!

Thanks for Reading and Good Luck Trading

Clive