A contract for difference (also known as CFD) is a contract between two parties: buyer and seller, specifying that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time.
However, if the difference happens to be a negative one, then the buyer pays to the seller instead. For example, when applied to equities, this kind of contract is an equity derivative that allows investors to speculate on share price movements, without the need for ownership of the underlying shares.
CFDs give investors the chance to take long or short positions. CFDs have no fixed expiry date or contract size, unlike futures contracts,. Trades are conducted on a leveraged basis with margins typically ranging from 1% to 20% of the notional value for CFDs on leading equities.
LEVERAGE YOUR INVESTMENT POTENTIAL
CFDs are traded on leverage, so it's possible to increase your exposure to an underlying asset from the same initial investment. To open a CFD trade, you need to deposit only a part of the total trade value, usually an amont around 1-20 percent, allowing you to take a larger position that would be harder to take if you had to fund it in full.
Leverage is great news if the market moves in the direction that you expect, but it becomes a risk if the market moves against you.
TRADE FINANCIAL MARKETS AROUND THE WORLD
CFD trading gives you access to a broad range of markets that usually are not available to retail investors. It is as easy to trade on the price movement of commodities such as oil or gold as it is to trade an individual equity. CFDs also let you to speculate on whole indices or sectors from one single trade.
PROFIT WHEN MARKETS FALL AS WELL AS RISE
By 'going short' (that is, selling), you can profit from a falling market as easily as you could profit from a rising market by buying it. If you think that a company or a market will have a loss of value in the short term,then you can use CFDs to sell it now, with the expectation that you can buy it later. However, if the price of your trade moves against you, your position will result in a loss.
HEDGE OTHER INVESTMENTS
Since CFDs offer the possibility of going easily as short as long, they can be used to provide a certain insurance against price falls in a portfolio. For example, if you have a long-term portfolio that you wish to keep, but you feel that there is a short-term risk to the value of your investments, you could use CFDs to damage-control a short term loss by 'hedging' your position. If the value of your portfolio falls, then the profit in the CFDs should offset these losses.