A Close Look at the Contracts for Difference Trading

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What are Contracts For Difference or CFDs?

CFDs or Contract for Difference (this tool is a product of OTC market) are agreements that two parties enter into, which specifies that the buyer will pay to the seller the value of the stock bought at contract time rather than at the current value of the asset. If the value of the stock shoots in the course of the time that the contract is in effect, the buyer pays the difference. If the value of the stock is negative, it is the seller who will pay the buyer for the difference. These CFDs are financial derivatives, much like a stock, bond or currency. It allows investors to ponder on share prices without actually owning those underlying shares. Contracts for difference are currently available in some of Europe’s major economies like the United Kingdom, France, Italy, Switzerland, Germany and Spain among others. Australia also offers CFDs as do South Africa. In Asia, only Singapore and Japan offers these forms of financial instruments with Hong Kong seriously considering getting into it. One of the leaders in the financial sector, IG Markets Ltd is part of the IG Group was founded in 1974. Learn more about IG Markets CFD Trading. CFDs are not available in the United States because of the U.S. Securities and Exchange Commission’s restrictions on over the counter financial instruments.

Why Consider CFDs?

CFDs are considered unique because they can be taken out on any form of asset. One of its benefits is that they are traded on margin meaning which provides the trader with leverage. Purchasing shares through a stockbroker requires one to pay the full price. A CFD can give you the same acquisition with a smaller amount. Holding long and short positions is possible with CFDs. The purchaser takes a long position if he speculates the stock to increase in value thereby obliging the trader to pay up on the difference. Taking a short position means exactly the opposite. In this situation, the purchaser would have to pay the price difference if the value goes up. If stock values go down, the trader is the one who pays the buyer. It is beneficial because it allows gains to be realized not only on the way up but also on the way down. CFDs allow significant gains but also terrible losses depending on the movement of the market. Because you don’t actually purchase the underlying shares, you are spared from paying stamp duty. This means 0.5% savings when compared to traditional share deals.

The Risks Involved

The risks of CFDs include the magnification of losses if the tide moves against you. When this happens, you can be exposed to significant losses unless you place a stop loss order. CFDs are less suited for long term investors because the cost associated with it increases. Not least of all is the fact that you have no rights as an investor which includes no voting rights.

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