Contract-for-Difference

A contract-for-difference (CFD) is defined as a contract between two parties, commonly described as a buyer and seller.

This contract specifies that the buyer will pay to the seller the difference between the current value of an asset and its value at contract time.

CFD trading is extremely volatile and carries large levels of risk, relative to other types of trading.

For example, should the difference be negative, then the seller pays instead to the buyer for the amount owed, leading to negative balances.

Starting in the early 2000s, CFD trading became more popular, namely in the United Kingdom following exemptions from capital gains tax.

This was due in part to the similarities and parallels between CFDs and spread betting profits in the UK.

CFD providers have since expanded globally and throughout the European Union, parts of Africa and Asia. Of note, CFDs are not permitted in a number of countries, due to regulations.

For example, this notably includes the United States, which due to rules regarding over-the-counter products, result in CFDs not being able to be traded by retail investors unless on a registered exchange.

However, there are at present no brokers in the US that offer CFDs.

Understanding the Risk of CFD Trading

CFD trading is inherently risky given that they are traded on margin. As such, the leveraging effect of this increases the risk significantly even with small positions.

This is due to margin rates being commonly small and therefore even incremental amounts of money can be used to hold a large position.

Overall, risk is central to CFD trading, which relies on speculating on movements in financial markets or to hedge existing positions in other products.

Investors often try to control for this risk by using stop loss orders, which can mitigate any potential losses to accounts.

Even with tools such as these, users often deposit an amount of money with the CFD provider to cover the margin and can lose much more than this deposit if the market moves against them.