A contract for difference, often shortened as CFD, refers to a contract between a buyer and seller where the buyer pays the difference of the valuation of a trading instrument when the contract is opened against the value of that same instrument when the contract concludes.
This article will go into more detail about what this means when you trade on CFDs.
An introduction to CFDs
CFDs allow traders to profit off of the price movement of an asset without ever owning the actual asset, with the price change between entry to exit being the principal focus. In other words, it is only the price of a trading instrument and not the practical underlying value of an instrument that is important for CFD trading.
How CFDs work
CFDs are contracts between a broker and client which are initiated by the client through a buy or sell order opened within a trading terminal (such as MT4 or MT5). Every trading instrument has its own set of Contract Specifications to inform the client of that instrument’s unique conditions and, while not always the case, a spread is charged by the broker upon the creation of an order.
- When a trader opens a Buy order: they are speculating that the price of the trading instrument will increase to earn profit from the difference, but will incur a loss if the instrument decreases in price.
- When a trader opens a Sell order: they are speculating that the price of the trading instrument will decrease to earn profit from the difference, but will incur a loss if the instrument increases in price.
A trader opens a Buy order on XAU at a price of USD 100, before the price grows to USD 120. If the trader closes the order at this time, they will profit USD 20 from the difference in price. The trader continues with the order open but the price of XAU now drops to USD 90. If the trader closes the order at this time, they will lose USD 10 from the difference in price from USD 100.
CFDs are unique in many ways, and it is advantageous to recognize these differences to mitigate risk and develop your own trading strategies.
- Global Access
CFDs give traders the opportunity to trade on a wide selection of trading instruments they would normally not have access to, and these instruments are offered centrally through the trading terminal of their choice.
- Minimising Costs
To trade assets through intrinsic ownership of the instrument, a trader would pay costly fees to officiate ownership including costly transaction and logistics fees. With CFD trading it becomes vastly more affordable to trade on the price of many trading instruments.
- Variety of Instruments
Metals, Indices, Cryptocurrencies, Energies, Stocks and Forex are all instruments available to a CFD trader with ease; they are centralised and do not require a trader to approach different marketplaces or brokers which specialise in these instruments.
- Higher Leverage
CFDs allow for higher leverage options, as is in the case of our Unlimited Leverage options, than traditional trading. This results in lower margin requirements for a trader and lower required capital for opening orders. However, this can magnify loss, so do please read more the impact of Leverage to mitigate risk.
- Short and Long Positions
Traditional trading may allow shorting of an instrument but with big barriers to entry. With CFDs, both Buy and Sell orders are equally accessible with no minimum requirements or steep borrowing costs.
- No Day Trading Minimums
Certain markets will impose a minimum daily trading volume for access to their provided instruments, but CFDs do not have such requirements. At Exness, only our Professional Accounts have a minimum initial deposit requirement but, once met, the deposits thereafter or the volume of trading is solely up to the trader to decide without any daily requirements whatsoever.
As you can see, there are many unique features that CFDs present that prove beneficial to traders. With lower margin requirements, the vast range of trading instruments, lower than normal fees and global access, CFD trading continues to be a very popular form of trading.