Among the financial derivatives most commonly used there are CFDs (Contract for difference).
Contract refers to the one stipulated between two parties defined as buyer and seller. Essentially, it is a contract between the client and the broker.
The difference is that between the current value of a share, currency, commodity or index and its value at the end of the contract. If the difference is positive, the seller pays the buyer. If it is negative, the buyer is the one who loses money.
As well as binary options, a CFD is a tradable instrument that mirrors the movements of the price of the asset underlying it. Traders will take advantage of prices moving up (long positions) or prices moving down (short positions).
Even if the underlying asset is never owned, CFD allows profits or losses when the value of the assets moves in relation to the position taken.
It is possible to trade CFDs based on indices, currencies, commodities and much more.
CFD is a leveraged product. This enables you to put down a small deposit to get access to a larger amount of shares. This is the reason why they are financially secured and so powerful as a tool.
CFDs are traded on margin, and the profit/loss is determined by the difference between the buy and the sell price. So, investors only need a small proportion of the total value of a position to trade.
Leverage also means significant benefits and risks: the investment capital can go further, but there is the possibility to lose more than the initial deposit. If the underlying asset is very flexible, it requires a high level of risk management.
The negotiation of a CFD is very similar to the trading of other financial assets. Their price, however, is almost similar to the one of the underlying asset.
A contract for difference starts with an opening trade on a particular asset. This creates a position in that asset. Once the position is closed, the difference between the opening trade and the closing trade is paid as profit or loss.
There is no expiry date. This means that any positions that are left open overnight will be reinvested and carried to the next day (usually this process takes place at 10pm GMT).
The contracts are subject to financing charges. In a CFD both parties pay to finance long positions and may receive funds for short positions instead of deferring sales procedures.
A stop loss order can be set to activate a way out whenever it is reached a level pre-determined by the trader. Once the stop loss is triggered, a sell signal is activated to the CFD provider, in accordance with their terms of business, taking into account the liquidity to complete the request.
CFDs were originally developed in the early 1990s in London for fiscal reasons, to allow institutional traders to operate on any asset avoiding UK tax.
In the late 1990s CFDs were introduced to retail traders, but it was around 2000 that traders realized that the real benefit of trading CFDs was not the exemption from tax but the ability to leverage any underlying asset.
To date, it has been implemented a general disclosure regime for CFDs to avoid them being used in insider information cases.
Advantages to CFD trading include lower margin requirements, easy access to global markets, no shorting or day trading rules and little fees.
It is possible to trade CFDs in the United Kingdom, Europe, Singapore, South Africa, Australia, Sweden and Japan.
CFDs provide an excellent alternative for certain types of trades or traders, but each individual must weigh the costs and benefits and proceed according to what works best within their trading plan.