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What is a CFD?
CFD is the acronym for Contracts for Difference. These are financial instruments where a buyer and seller enter into a contract to exchange the difference between the price of the underlying asset at the time that the trade is opened and the time it is closed. The difference between the price of the asset at the time the contract is opened and closed is the payout amount.
CFD trading began in the 1990s so it is a well accepted and liquid instrument. CFDs are used by hedge funds and institutions as a cheap form of portfolio protection. Since CFDs can be traded from both the short and the long side, traders can profit from falling as well as rising prices.
What is CFD Trading?
CFD trading comprises the trading of CFDs between two parties – the buyer and the seller.
Characteristics of CFDs
CFDs have their own unique characteristics as follows:
- When trading a contract for difference, the underlying asset is never purchased. The CFD is a contract between the trader and the counterparty in a tradable instrument that replicates the movement of the underlying asset, deriving its price from that underlying.
- CFDs are traded on margin. The margin must be available in the account as security against the position. Consequently, CFDs provide potentially enormous leverage to any movement in the underlying asset.
- CFDs are marked to market. This means that the account position is constantly monitored in real-time. Potential profits are notionally credited to the trader’s account and unrealized losses must have sufficient margin coverage.
- CFDs have no expiry. If a trader wants to hold a position overnight, they are charged a fee financing charge usually based on a benchmark (interbank) rate.
- CFDs have small contract sizes. This means that almost anyone can trade CFDs.
- CFDs are available for an extensive range of commodities and indices.
CFDs – a Practical Example
- A trader thinks the gold price will appreciate.
- Instead of buying a physical ounce of gold for $1,250, they buy 20 gold CFDs on a 1% margin ($12.50/CFD) costing $250.
- Buying commission of 0.0065% or $162.50 (20 x $1,250 x .0065) is paid.
- Gold is trading at $1,270 and the trader decides to close the trade.
- The gross profit is the notional sale price of $1,270 less the notional purchase price of $1,250 or $20 per CFD, equating to $400.
The net profit is the gross profit less the buying commission of $162.50, or $237.50.
NSFX provides clients the opportunity to trade an extensive range of CFDs at the most flexible and competitive rates.