Why Trade CFDs - Contracts for Differences

Posted: 5th March 2018 15:52

The world financial markets are evolving quickly.

A few years ago, it was impossible for people from certain countries to participate in the CFD market. The technology was not available and the costs for transactions made all this unaffordable to many people.
Today, all this has changed.

Every day, people from developed countries like New York to developing countries like Zimbabwe are participating in this market thanks to the available technology, and financial products like Contracts for Differences (CFDs).

What are CFDs?

CFDs are financial instruments that involve traders and financial institutions like investment banks or online trading firms. In simple terms, a CFD is an agreement between the two parties to pay each other when there is change in the price of an asset. When the price of an asset moves, one party pays the other the difference from the time when the contract was agreed to when it ends.

A good way to explain this is to consider a company like Facebook, which is listed in the NASDAQ. As at now, it is near impossible for an average trader in Asia to buy the stock. This is because the US regulations require stringent Know Your Customer (KYC) regulations. The same is true for other companies and countries. For example, it is tough for people in Africa to buy stocks for German companies like SAP and BASF.

CFDs make it easy for people from around the world to buy complex financial assets they would not be able to buy in the real world. For example, without CFDs, it would be very difficult for people to trade and benefit from the complex world of crude oil, gold, and even cryptocurrencies derivatives.

The difference between buying real stocks and CFDs is that with the former, you own a stake in the company. For example, when you buy stocks of a company, you become a part owner in the business with certain rights. You get rights to vote for a company’s directors, demand management changes, and even receive a dividend. When you buy CFDs, these opportunities don’t exist. You don’t become a shareholder and you don’t get rights to make any decision on the company.

Other than accessibility, CFDs are cost effective ways to trade and participate in the financial market. Unlike when buying stocks where you are required to pay a commission, with CFDs you don’t pay any commission or stock duty. Instead, you pay the spread between the bid and ask prices of an asset. Also, you get a chance to use margins and leverage, which can make it easy for you to make more money.

Another benefit for trading in CFDs is that the rules for short selling that exist in the convectional market don’t exist here. Therefore, when trading in CFDs, it becomes very easy for one to short sell a financial asset. By short selling, you can benefit when the price of an asset goes down.

There are some downsides for trading in CFDs. First, because you benefit from the spread between the two prices, it might be difficult to profit from small market moves. Secondly, there are thousands of brokers who provide these services. Because of the ease of entry in the business, many companies in the industry are not regulated, which means unless you do due diligence, you could lose your money. Finally, some brokers might charge a lot of money per trade indirectly through the spread they offer.