Find Out About Contracts For Difference
CFD means Contract for Difference, a Contract for Difference is a type of derivative taken out between two parties, the buyer and the seller. The seller of a Contract for Difference has an onus to pay the difference between the market price of a share or other instrument on which the Contract for Difference is based and the price of the contract when it was sold to the buyer. If the difference is negative, the buyer pays the difference to the seller.
CFD trading started in London in the 1990s. It was in the year 2001 that investors realized that Contracts for Difference had significant benefits over traditional share trading, the main benefit was the avoidance of stamp duty.
CFDs have a number of benefits over ordinary stock trading. The main benefit is that no CFD expires and the holder of a Contract for Difference is required to maintain a minimum margin amount, much less than buying stocks or futures contracts outright. For an investor to ensure that they earn money through Contract for Difference trading, it is essential that they calculate risk, study market trends on a frequent basis and avoid margin calls which can occur should the CFD position move against the buyer. traders can go short or long and use stop loss orders enabling them to reduce their losses.
There are many types of financial products available allowing investors to invest their money in order to profit. Depending on the level of knowledge an trader has they will choose the right financial product to suit their needs. If we compare all types of financial instruments, then it can be said that Contract for Difference trading is most similar to futures trading with the additional benefit of liquidity and leverage.
Below are four of the main benefits of CFDs for short term traders
1. Overnight financing
Contracts for Difference are the perfect choice for short term day traders and there are a few important reasons for this. Firstly, CFDs incur a financing rate when you hold a position overnight. The financing for long positions is usually the Reserve Bank rate or cash rate. So if the Reserve Bank rate is 4.25% then you pay 6.25% per year calculated back as a daily rate as the CFD provider will add a haircut of around 2% on top of the Reserve Bank rate. You can avoid financing charges by closing your position before the day is over.
2. CFD Leverage
Another reason that Contract for Difference trading strategies are so popular is leverage. If you had $5,000 in a share trading account then you could only trade $5,000 and a 5% move on $5,000 would only be $250. If you took that same $5,000, invested in CFDs and opened a $20,000 position, that same 5% move now equates to $1,000. Thus with Contracts for Difference you can potentially make another $750 with no additional outlay .
3. Liquidity
The key for short term day traders is liquidity, unlike other derivative products such as options, CFDs mirror the liquidity in the underlying exchange. When trading using a Direct Market Access provider you can see the precise volume available on each stock CFD at each price level in the market depth.
4. Low brokerage
A significant advantage of Contracts for Difference for investors are their low brokerage rates. Some brokerage products such as index CFDs are brokerage free. If you are trading the top 300 ASX CFDs , the brokerage rate is still low. Typically commission providers charge a minimum of $10 or 0.1%.
If you want to find out more about Contracts for Difference you can visit our Contracts for Difference page and you will discover a host of similar trading facts. You can find out more about CFD trading by visiting International Capital Markets website.
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