Contracts for difference

CFD trading or contract for difference trading is an agreement or a contract between two entities: the buyer and the seller. The contract stipulates that the buyer will have to pay the seller whatever difference there is between the assets current value as opposed to its value at the time of the contract. Should the difference be a negative amount, then the seller pays instead. Since no exchange of goods takes place, CFDs are not subject to stamp duty and have a preferential tax treatment.

CFD trading is a financial derivative where the value of an asset will depend on the underlying variables. Commonly, these are futures, options, and swaps, but they could also include assets which are tradable like stocks and commodities. It could also mean non-tradable assets like any form of economic index. This is basically a contract where the payoff will depend greatly on how the benchmark behaves.

The long and short of it is that CFDs can allow the traders to benefit from prices which go up, or are in long positions. They are also allowed to benefit from prices which can drop, known as short positions. The underlying financial instruments are those which are used for market speculation.

To better understand how this works, here is a simple example. When it comes to equities, the CFD trading is called the equity derivative. This will allow the traders to make a speculation on the movements of the share prices. They do not need to own any underlying share.

Compared to other products, CFD trading is considered to be more advantageous, although the opinion really varies from trader to trader. The advantages include a lack of an expiry date so the prices do not decay, there is no need to trade on exchange, the contracts are one on one, and the size of the contract is usually small. Some traders would claim that the lack of a US presence is actually a benefit, but then again, this can still be based on opinions.

There are also a lot of criticisms on this type of trading based on how the trading is marketed and the fact that there are a lot of inexperienced traders who can be taken advantage of.

CFD trading is not allowed within the United States but it is being practiced fully in countries like the United Kingdom, New Zealand, Australia, Singapore and Switzerland. There are actually 18 countries in Europe and Asia which allow this type of trading. The US Securities and Exchange Commissions have made strict restrictions on this type of trading activities.