Originally developed in the early 1990’s in London, contract for difference (CFD) has gained its popularity over the last several years. CFDs allow traders to take advantage of an underlying financial instrument’s price movements without actually owning the underlying financial instrument. Shortly after CFDs were made available to the retail traders (Individuals like you and me), people started to realize that the biggest benefit of trading CFDs is the ability to leverage; from there, the number of CFDs retail traders has skyrocketed and the available CFDs expanded from London Stock Exchange shares to include indices, global stocks, commodities, bonds and currencies. Today, the most popular type of CFDs are the major global indexes. (If you have absolutely no idea how CFD works, CMC Markets does a great job explaining it).
There are many reasons why the popularity of CFDs trading has been increasing; comparing to traditional trading, CFD does appear to be more retail traders friendly, here are the key advantages of trading CFDs:
The inherent advantage of trading on margin
This means that you only have to deposit a percentage of the overall value of the trade to make the trade while taking on the whole profit or loss. For example, if you’re buying 100 shares of a stock CFD at $20 a share, the total value of the trade would be 100*20 = $2,000. Now, assuming only a 5% margin is required by your CFD provider, then the cash outlay of this trade is only $100.
This, of course, could sometimes backfire as both the profit and loss is calculated using the whole value of the trade. Like all investment, it is advised that you monitor your positions closely.
Although in traditional trading, traders can also trade on margin, but CFDs provide much higher leverage than traditional trading, this means a much lower margin requirement, and hence, less cash outlay for each trade.
Global Market Access
In traditional trading, and especially for retail traders, it could be very difficult to access foreign markets. However, most CFD providers offer products in many major markets around the world, allowing CFD traders to trader any market as long as the market is open.
Low entry threshold
In CFD trading, the minimum contract sizes are usually very small, it is even possible to buy one share CFD, along with its high leverage nature, this means that you can start trading CFDs with little capital. For beginners with no prior trading or investing experience, this is a great place to start small and get your feet wet.
Variety of trading options all in one platform
Stock, index, currency, commodity… Pick your financial vehicles or mix and match. All in one platform.
No fees or low fees order types
Most CFD providers offer order types as traditional brokers like stop orders and contingent orders. Most of these executions are offered without a fee or with a very low fee in CFD trading. Additionally, many CFDs providers don’t even charge commissions. This is because many of the CFD providers make money in the spread, which is the difference between sell and buy prices. The spread is often fixed, sometimes a “dynamic” spread is offered by the CFD providers, which is a spread that is adjusted according to the market conditions.
In volatile times, CFDs have emerged as a popular tool to take advantage of the market condition, with its simplicity and wide reach, it has even become the main trading tool of many retail traders. However, like all investing and trading activities, it is important to maintain discipline and closely monitor your positions.
Choosing a CFD Provider
All CFD providers should regulated and licensed by a major oversight body in the government. For example, in Australia, The Australian Securities and Investments Commission (ASIC) is the major oversight body that supervise rea-time domestic trading and Australian Financial Service License (“AFSL”) holders.