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Defining a Contract For Difference

By: Alexandra Gilmore.
Date Added : July 13, 2011 Views : 29
Rate Author : Current : 2.82 /5
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Contracts of Difference (CFDs) are among the fastest growing trading instruments in the financial sector. As the name suggests, this contract is a contract between two parties speculating on the price of an asset or in the movement of the price of an asset. In a Contract For Difference there are two parties namely the buyer and the seller. They agree that should the price of an asset increase, the buyer will get paid by the seller and should it drop, the buyer loses his money. This service is provided by the seller for a commission that is stipulated in the contract of difference.

There are no restrictions or limitations as to the life of the contract. This means that a Contract For Difference can run as long as the parties want it to run. They are not limited like options or future contracts. As opposed to an expiry date, CFDs will be renewed after the close of each day. But, it is advisable to invest for a short time in CFDs as it is a leveraging instrument, having high risks therefore it is not suited for a long term investment strategy. Another reason why it’s advisable to engage in short term Contract For Difference investment is that there are charges that are incurred for the hedging of the instrument. This being a high risk instrument, such charges can end up being too expensive in the long term.

The fact that contracts of difference are traded on leverage is also an advantage to the investor. This is because it gives the investor more flexibility, opportunities and power to trade with the assets. Also in contracts of difference, the investor does not have to pay the full stated price of an asset. He can take out a position on the asset for as low as 10% of the face value of the asset. This is referred to as the margin. When you enter into a contract of difference, one does not buy the asset, rather you take out a position in that share as noted above although an investor will enjoy the benefits enjoyed by other share holders who have actually bought the share because a Contract For Difference mimics the movement of the underlying share.

In order to begin CFD trading, an investor needs to open up an account with a CFD provider. From there the investor can be able to access CFD either over the counter; that is by going to the CFD provider directly or over an internet platform provided by the CFD provider. These platforms are secure and are supported by many handheld devices such as Blackberry, Android Smartphones, and iPhones. Therefore an investor in CFDs will be able to trade throughout the day with all his accounts in one place.

It is also worthy to note that when one chooses to trade Contract For Differences in the long term, he will receive dividends and pay interest. For the short time trader, he will pay dividends and receive interest. Commission is however paid out in both sides of the contract and one can opt out of the contract at any time.





Alexandra Gilmore is the author of this article on CFD. Find more information on CFD Trading here.

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