A Contract for Difference is an agreement between investors and CFD brokers to exchange the difference in value of a particular share between the time a contract is opened and the time at which it is closed. CFDs have grown in popularity over the last ten years as they allow investors to trade on a wide range of markets without physically having to own anything.
Contracts for difference are particularly popular with small retail investors as it is not necessary to pay for the full value of a chosen position. All that is needed is a small deposit (margin) which can sometimes be as low as 5%. This means that investors who do not have vast amounts of financial reserves can trade up to 20 times their initial capital.
Rise & Fall
Investors can also make a potential profit if the market goes down, as well as up. One of the most significant features of CFDs is the ability to trade on both the long and the short side of the market, (taking a ‘long’ or ‘short’ a position). Going long involves buying the right to purchase stock at some point in the future, but at its current price. Conversely, purchasing a short CFD entails entering into a contract that compels CFD brokers to pay out the difference in share prices should shares go down in value. If an investor is ‘long’ then they will receive dividends and pay interest and if they are short then they will receive no dividends nor pay any interest.
Future
Although growing, the CFD market is still relatively small. However, as the wounded UK economy puts its darkest days behind it, the CFD market will see transaction volume increase as more and more dynamic investors access the markets with a resurgent confidence.