By Vincent Parker – Contracts for Difference (CFDs) can be quite confusing. Here is a quick article explaining CFDs, leaving Contracts for Difference explained once and for all.
Contracts for difference are a contract created between two different parties, stating that one party will pay the other party the difference in the value of that contract at a point in time in the future. One party will expect to receive money if the value of the contract is higher, while the other will expect to receive money if the value is lower.
In the real world, the contract is created between a trader and a CFD broker. The contracts are open ended, unlike a future contract meaning that its up to the trader to decide when to close the trade and collect (or pay) his money. From this sense, CFDs work much like a share trade.
Contracts for difference are usually traded on leverage, meaning you only need a small portion of the trade funds to execute the trade. For instance, if you were to open a position of $10,000 and the margin was 10% you would only need $1000 to open the position. This means that much larger profits can be achieved with smaller amounts of money.
The fact that you take a position out on leverage, means that there is an interest element associated with your purchase. And you will find yourself paying and an annual interest rate a few percentage points higher than the official cash rate.
Another great thing about CFDs is that it’s very easy to open a short position. What this means is that you can actually trade on the value of a CFD going down instead of up. Something that was very difficult until this tool was created.
A CFD is priced based on the value of the underlying asset. The underlying asset could be a share, currency, commodity or indices in many markets. The flexibility of the different types of assets you can trade with CFDs is unparalleled by anything else. Which is why if you are looking to get into short term trading, anything from spread betting, FOREX trading or day trading, CFDs are your best option.
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