CFD stands for Contract for Difference. It is a derivative instrument, in the form of a contract between a buyer and a seller, that allows trades of the live market price differences of an underlying instrument, but without actually owning that instrument (hence the ‘derivative’). The two parties to the contract, typically known as the ‘buyer’ and the ‘seller’, agree that the seller will pay to the buyer the difference between the current value of the asset and its value at contract time. If the difference is negative, then the buyer pays instead to the seller.
CFD’s have certain advantages over straight stock ownership:
· CFD’s are leveraged products, meaning that you can control a greater number of shares or contracts for a given amount of money. This leverage can be up to 10 times. There is the potential for magnified gains if you are correct, but magnified losses if you are wrong. However, it is possible to limit your losses by well-placed stops, which for a fee can even be ‘guaranteed’.
· If your view is that the price of a particular instrument is likely to fall, or if you want to hedge your portfolio against a possible fall, CFD's enable you to take a ‘short’ position. In many markets it is not allowed, or at least it is made extremely difficult, to short stocks, so this can be a real advantage, especially if you want to follow a strategy that is ‘always in the market’.
· Some markets levy stamp duty on stock transactions, but this can be avoided when trading CFD’s as you do not own the underlying instrument.
· CFD’s can give you access to a wide range of markets, all through one provider. So the typical CFD provider will offer stocks, indices, sectors, currencies, bonds, interest rates, metals, and commodities. You will be spoilt for choice, but whilst having such a wide range of markets available is very tempting, it is usually better to get to know one market – and of course we recommend sticking to stocks!
CFDs are currently available in the United Kingdom, Hong Kong, The Netherlands, Poland, Portugal, Germany, Switzerland, Italy, Singapore, South Africa, Australia, Canada, New Zealand, Sweden, Norway, France, Ireland, Japan and Spain. However, they are not currently permitted in the United States, due to restrictions by the U.S. Securities and Exchange Commission on over-the-counter (OTC) financial instruments.