Contracts for Differences, CFDs, is a financial product that enables investors to profit without owning the actual underlying asset. Technically, it is an agreement between a buyer and seller to agree on the difference between the current and future price of a security from the time the trade is open until its close.
In short, a CFD is a means of exchanging the difference between an opening price and closing price in the form of a cash payment as opposed to a physical product or ownership of the security itself. It also happens to be an ideal means of benefiting from price differences without actually claiming ownership of the underlying security. However, similar risks are involved with CFDs as are with vanilla options and spot forex trading.
With CFD trading, the price difference of the instrument is multiplied by the number of units in your contract. What do I mean? Let’s suppose you purchased 100 oil CFDs for $1,200 and it is then sold for $1,400 after a few weeks. Without including transaction fees, the formula for calculating your profit should look something like this: (($1,400-$1,200)*100) = $20,000. The same calculation is applicable if you sold an instrument rather than longing it.
How does it compare with trading other derivatives?
Like vanilla options or future contracts, CFDs offers you a wide range of financial instruments to trade. These include stocks like Facebook, Nike and Ferrari as well as commodities like gold, oil and sugar and indices like the DOW, the DAX and the S&P 500. The main difference between regular (vanilla) options and CFDs is that with CFDs, there’s no expiry date. You can leave your position open for as long as you want.
However, unlike derivatives such as spot forex trading, CFDs don’t require you to trade currency pairs exclusively. This gives you a wider range of choices when it comes to trading CFDs.
So how is it different from Spot Forex?
Unlike spot forex trading, CFDs allow you to trade a more than just currency pairs. CFD trading involves opening positions on a diverse range of instruments including indices, shares and commodities. This means that with CFDs, you can trade the oil against the dollar, Tesla shares or the S&P 500. That way if tracking Apple’s success interests you more than the relationship between the Swiss Franc and the Canadian dollar, CFDs may be more appropriate for you (as opposed to spot forex).
Want to learn more? Check out our What is CFD Trading article.