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A contract for difference (or CFD) is a contract between two parties, typically described as "buyer" and "seller", stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time. (If the difference is negative, then the buyer pays instead to the seller.) For example, when applied to equities, such a contract is an equity derivative that allows investors to speculate on share price movements, without the need for ownership of the underlying shares
Contracts for difference allow investors to take long or short positions, and unlike futures contracts have no fixed expiry date, standardised contract or contract size. Trades are conducted on a leveraged basis with margins typically ranging from 1% to 30% of the notional value for CFDs on leading equities.
CFDs are currently available either unlisted or listed [i.e. mini-warrants and ASX CFDs listed on the Australian Securities Exchange] and/or over-the-counter markets in the United Kingdom, The Netherlands, Germany, Switzerland, Italy, Singapore, South Africa, Australia, Canada, New Zealand, Sweden, France, Japan and Spain. Some other securities markets, such as Hong Kong, have plans to issue CFDs in the near future. CFDs are not permitted in the United States, due to restrictions by the U.S. Securities and Exchange Commission on OTC financial instruments.
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Use of leverage to enhance returns and levels of market exposure. Gearing can also provide tax benefits as the costs of investing - such as interest repayments are generally deductable. Low transaction costs. Transparency and ease of execution. Trade long or short with equal ease. Trade any time frame - no fixed expiry date. No fixed contract size - trade the number of shares you choose. Less complex than options and warrants.
Receive dividends when long (but no franking credits). Participate in rights issues, share splits and other company activities. Stop loss and contingent orders easily placed. Online account reporting and daily statements.
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Short trades Contracts for difference allow traders to go short as easily as long, which was earlier available only for professional investors. But with the help of CFDs, short positions become more effective regarding their cost and simpler regarding their establishment than share dealing.
Low commission and margin requirements You can perform operations without having a deposit that covers the entire sum of the contract, but only margin that is 5 - 10 percent from the amount of the contract. This allows you to make portfolio investments without binding all your funds.
Hedging If you have some shares you do not want to sell even in case you expect their price will go down, you can just go short under a contract for difference on this share (or portfolio). In this case you will compensate the losses you will have with your basic holdings by the profit made with the corresponding CFD.
Market prices While working with CFDs instruments, you get market spreads without any extension and it allows you to trade at the prices that stock professionals make their deals at.
Quick dealing With CFDs, all deals are made at once without waiting for execution.
Deal size The minimum deal size with a CFD is 0.1 lot = 10 shares.
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Contracts for difference enable your money to work much harder for you through CFD Leverage. In the example above with $10,000 worth of BHP CFDs, your position may only move in your favor by 5%. For example BHP moves from $40.00 to $42.00 then your $10,000 position is now worth $10,500 which represents a gain of 5% (trading costs excluded in this example), therefore you have just made 100% return on your initial $500 margin outlay.
Contracts for difference (CFDs) can also lead to losses, so traders need to be mindful of the CFD Risks, how to place appropriate stop loss orders and use sensible money management rules. If in the CFD example above BHP dropped from $40 to $38 then the CFD position would have lost $500 (trading costs excluded in this example)
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