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CFDs: What You Should Know About It

Martin Castilla            No comments            Jan, 25

Contract for Difference (CFD) is a form of derivative trading where the seller pays the buyer the difference between an item’s current value and its value during the contract period. However, when the difference becomes negative, the buyer will pay seller instead. This kind of market trading permits one to figure out the rise or fall of prices in the financial market.

How CFD Started

CFD was originally developed in London in the 1990s  as a kind of equity swap. The people behind it were Jon Wood and Brian Keelan. CFD was first used to cover their exposure stocks on the London Stock Exchange. Soon after, it spread from London to countries in Australasia, Africa, and other parts of the world.

CFD was exclusively traded over-the-counter on its first few years. Australia was the first ever country that proposed exchange-traded CFDs. It happened when the Australian Securities Exchange launched CFDs on 50 shares, a number of global indexes, a couple of commodities, and 8 forex pairs in November 2007.

Understanding How CFD Trading works

CFD trading doesn’t tell you to just simply buy and sell an underlying asset.  As a trader, you will either sell or buy a number of goods after an in-depth analysis. Your decisions will depend on your intelligent predictions about the price increase and decrease.

Let’s say that you have a stock amounting to $100.00, and the cost of 100 shares with the same price is $1000. The traditional broker will charge you with almost 50% of the margin, so you need $5000 in cold cash. However, if an expert CFD broker will only charge you 10% of the margin, your cash expenditure will dramatically reduce to just $100.

 Advantages of CFD

  • Leverage is Greater

CFDs provide a much greater leverage than traditional trading. At least 2% margin requirement is needed in conventional trades. However, you will have to consider the margin requirement of the underlying asset which can go up to 20%.

  • Has no Expiration

Unlike futures or spread bets, CFDs never expire. You can buy or sell shares today, and your position is still secure after a year.

  • Operates on Low Cost

Ideally, this one is the principal advantage of CFD trading. It is due to lower margin requirements and lesser regulated market.

Disadvantages of CFD

  • Leveled Tax

Tax can always turn an advantage into a disadvantage. The more profitable you become, the higher tax you’ll have.

  • Increase in Losses

Excess in the use of leverage can result to overtrading. Overtrading will expose your account to a significant loss. Make sure that you are designing and utilizing a sound and well-tested risk strategy and money management strategy that can secure your equity.

  • Lack of Ownership

CFD has no underlying ownership other than the contract itself. With CFD trading, there is no asset aside from its current market price.

Conclusion

CFD provides a powerful method to trade the financial markets. Since it is quick and accessible, it removes the need to trade through a stockbroker.

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