CFD stands for Contract for Difference. CFD was first launched in early 1990s in United Kingdom at the request from some institutions and hedge fund trader. They can take advantage of the price change, rising or falling. Those products are mainly characterized by their very high leverage effect and the possibility to invest in a range of sub-jacents. There are five main types of CFD:
The CFD on action that allows to trade the main titles (Total, Veolia, Vivendi etc …);
CFDs on indices (CAC 40, Dax, FTSE-100 etc …);
CFDs on commodities (oil, corn, wheat, cotton, soybeans etc …);
CFDs on metals (gold, silver etc …);
CFDs on currencies.
Who Have The CFD Priority?
Although online brokers are trying to popularize the CFD, it is very important to note that those financial derivatives products are rather intended for a discerning audience. By advertising the simplicity of the CFD and the potentially huge gains, the brokers forget to specify that CFDs involve numerous risks for novice trader who,often has no conscience. Therefore, CFDs rather turn to investors who already control the functioning of financial markets and have a strong experien. CFDs are a good opportunity to diversify the investment portfolio effectively with riskier assets but potentially more profitable.
Suppose you expect an increase in the total share of the London Stock Exchange. The title is currently trading at 45 euros and you are targeting48 euros. You buy a CFD on a share at the value of 900 euros which represents 20 titles. Every day the contract credits or debits the difference between the purchase price and the current market price. Starting with a margin of only 5%, which corresponds to 45 euros. We suppose the day after your purchase, the Total share climbs to 46 euros, then you will win (46 – 45) x 20 = 20 euros. If your goal is reached 48 euros, your performance will be then: [(48 – 45) x 20] / 45 = 133%!
What Are The Advantages Of CFD?
CFDs have many advantages:
Easy to trade which allows almost all investor profiles to invest on its;
Strong liquidity that allows to have a leverage that can reach 500 with some brokers;
A leverage which represents only 5% of the open position. Thus, with a margin of 50 euros, you can have a CFD contract of 1000 euros;
No influence on the prices of markets maker;
Commissions * extremely low;
No monthly liquidation.
* If you leave your position open beyond a day, sometimes significant interest apply to it,so it is advisable to inquire beforehand with your service provider.
What Are The Disadvantages Of CFD?
Risks associated with CFD are as numerous as the advantages:
The rules are very deficient because the CFDs are not “investment products” and are not accompanied by a prospectus approved by the United Kingdom regulatory authorities. However, the brokers specialized in CFD must have a good uniform license;
There is no compensation mechanism with CFD that can help to ensure the execution of the contract in the event of failure of the service provider;
CFDs are often accompanied by an extremely high leverage that can often be a source of inconvenience for novices who apply the wrong strategy of money management. The more the leverage is important, the greater is the losses potential, which can lead to a total loss of your capital.
We recommends to use CFD just in the case of a good knowledge about the financial markets and in the context of a strategy for asset diversification towards more gains but inevitably more risks.
We should note that CFDs on currencies pose no significant advantage to Forex Spot. Indeed, it is already possible for investors to benefit from forex high leverage (up to 200), to enter in the market to both upward and downward and enjoy low fees offering by brokers. It is often better to go directly to the Forex Spot for anyone wanting to invest on currencies. So you can enjoy the very effective market regulation which results to better protection for investors.
Finally, before choosing your broker specializing in CFD, it is always good to check if he has a license issued by the FSA or European Market Autority.