Contract for difference (CFD’s) were once used by hedge funds and other investors as a way of covering their exposure to stocks. And the financial spread betting market shares similarities with CFD’s and is often linked to CFD’s markets in countries where spread betting is popular.
Essentially, with CFD’s you can take either long or short positions (speculate) depending on your view of specific share movements. Unlike other financial instruments there is no need of assuming ownership of the shares involved.
CFD transactions are carried out without the use of standard contract terms, but rather CFD providers draft their very own terms and they collect commissions and account management fees for their troubles.
Individual traders initiate a transaction on an instrument of their choice, the profit or loss is determined at the closing of trade, and depending on the position taken by the trader, a corresponding movement is rewarded with profit and vice-versa.
Traders must adhere to the minimum margin levels due to the CFD’s dependency on margin trading, the margins are generated in real time and the contract for difference does not expire, allowing for roll over of open positions at the end of the trading day.
However, if the trader allows his or her positions to fall below the minimum official margin, the CFD provider could simply terminate the positions. Traders have the opportunity to update them prior to liquidation or termination of the position by making timeous margin calls.
The normal margin or percentage for equities ranges from 3-15%, and financing charges applying for each night a trader holds or maintains a position (overnight financing). Such positions are motivated by the speculative approach which continues to hold until there is a shift or movement on the shares involved.
Whenever the movements are favorable to the traders speculative positions or otherwise, the trader can then decide his next move, a favorable shift means the trader has the option of closing the position and taking net profit.
Some of the contract for difference transactions involve index based CFD trading which is done according to movements on a given index, such as the S&P 500. Commissions and charges still apply on these types of trading, thus whatever profit or loss you make the resultant balance is always minus these costs.
CFD trading demands heightened awareness as regards pertinent factors like position sizes, overnight financing costs, surplus funds for covering possible losses, and this is best done by keeping abreast with risk permutations through proper calculations.