A CFD (contract for difference) is a pact between a seller and a buyer that specifies the buyer is obligated to reimburse the seller for the difference between the existing value of a fundamental asset and its value when the contract was completed.
CFDs provide investors with an opportunity to gain from a price variation without holding the fundamental asset. The value of a CFD pact does not account for the asset’s fundamental value; it only accounts for the price variation between the trade entry and exit.
A CFD trader never really owns the fundamental asset but instead gets profits based on the price variation of the asset. Some benefits of CFDs include getting the fundamental asset at a lesser price than buying the asset entirely.
This can be done via a contract between the trader and the CFD supplier. The pact does not include any forex, stock, or futures exchange. First, let’s look at how CFDs work and the countries where CFDs are authorized for use.
How Do CFDs Work?
The use of CFDs is an advanced technique that’s only used by expert traders. In CFDs, there is no option to get securities or physical delivery of goods. The trader never really owns the fundamental asset, but gets revenue when the asset price changes.
For instance, rather than purchasing or selling real gold, an investor can gamble on whether the price of gold will rise or fall. Basically, investors can use CFDs to make hedges about whether the cost of the fundamental asset will go up or down.
If a trader has bought a CFD and notices that the asset’s price has risen, they will offer their contract for sale. The combination of the buying price and the selling price will give the net difference. This variation represents the profit gotten from the trades done through the investor’s brokerage account by the CFD supplier.
In Which Countries Can You Trade CFDs?
CFD contracts aren’t authorized in the United States. The SEC (Securities and Exchange Commission) has barred the trading of CFDs in America; however, non-residents can still use CFDs without any prosecution whatsoever.
There are many other countries where CFD contracts are authorized, including Britain, France, Spain, Italy, Germany, Norway, Belgium, Denmark, Netherlands, Switzerland, Singapore, Thailand, Hong Kong, South Africa, and others.
Australia also allows the use of CFDs, but the ASIC (Australian Securities and Investment Commission) has declared some changes on how CFDs are issued and distributed to clients.
What Are the Settlements Related to CFDs?
Some of the costs allied to CFDs include a monetary cost and commission in some situations and the spread. The spread is the difference between the purchasing price and the offer price when the trade is completed.
There is no commission placed on trading commodities and currency pairs. However, CFD suppliers usually charge a commission on stocks.
For instance, a supplier such as CMC markets which is based in the U.K. charges commissions starting from 0.02 USD per share or 10% for Canadian and U.S listed shares. The entry and exit trades are deemed to be two isolated trades, and you will be charged a commission for each.
A funding charge can be placed if you hold a long position because overnight positions for commodities are deemed to be investments, and the supplier has lent the investor cash to purchase the fundamental asset.
Investors usually are charged interest on all days they maintain the position. For instance, if a trader wishes to buy CFDs for the share price of Pfizer. The trader can place a 20,000 USD trade. The current price of Pfizer shares is 45.00 USD, and the investor expects that the share price will climb to 47.50 USD. Therefore the bid-offer spread will be 45.00 – 47.50 USD.
The investor will pay a commission of 0.1% on the entry position and a further 0.1% on the exit position. For holding a long position, the investor will incur a funding charge of about 2.5%
All in all, CFDs facilitate easy access to global markets, but due to the high leverage, when an investor suffers losses, they are overly amplified. This is why agencies such as ESMA (European Securities and Markets Authority) have placed margins on CFDs to safeguard investors.