Contracts for a difference, CFD is an interesting investing opportunity in the stock markets. A contract for difference is as simple as it sounds. There is a buyer and seller who set-up a contract in during the beginning of the trade and the person makes money depending on the price of the stock during the closing trade.
Contracts for difference are prevalent in many countries like Russia, Singapore and some European countries like France and Australia as well. But in the United States they are highly regulated as they are considered Swaps and they come under a particular law that needs to be followed.
Contract for Difference Trading Singapore
A trade is done with a CFD provider and this is how it works.
Step 1: You decide on a stock for example, Facebook at the price of $108.
Step 2: You decide to purchase 100 shares at $110 (100 X 110 = $11000)
Step 3: The trading fee of $100 is added to it and the total cost is now $11100
Step 4: Say hypothetically Facebook’s share price at the end of the day goes to $118.
Step 5: This means the value of your holding comes to (100 X 118 = $11800)
Step 6: So your profit is ($11800 – $11100 = $700)
The above is a simple example of how the price movements during a day can get you a profit or a loss. If in the above example, if the Facebook stock went down then you would have made a loss.
CFD Trading Meaning
Pros and Cons of CFD trading
- The Ownership of Shares:
As CFD’s are just contracts there is no trouble of owning a stock. This is perfect for traders who do not have to deal with the exchange, but just the brokerage companies that deal with CFD’s
One of the biggest pros of CFD’s is Dividends. You can actually get paid the dividend provided by the company. CFD’s are aimed at taking the benefits of all the stocks without actual ownership, this means getting paid dividends.
CFD’s aren’t restricted to only stocks, but Indices, mutual funds, currencies and commodities. This gives traders the chance to play to their strengths and take advantage of the price differences.
- Stop loss availability:
CFD’s can be pretty risky and that is why it’s always a good sign to be able to stop your losses. Brokers offer this option to CFD trader’s to cut their losses. This is probably the most important option for a CFD trader.
- Not based on Fundamentals:
CFD’s are ultimately not fundamentally strong Investments. They are not what you would call Investments that’ll be bought by the likes of ‘Warren Buffet’. This means you cannot build for the future with Investments like CFD’s.
CFD’s are almost like loans given to traders by the brokers. This means an Interest has to be paid when the trade is extended by more than a day. This is quite a big con because CFD trades are mostly small margins because of the price differences that are not huge between opening and closing. This added cost can eat on the profits or add on to the losses.
3. High Risk
CFD’s are extremely risky and they are probably only for a certain kind of a trader who wants to make a lot of money but with a lot of risk! Normal Investors and especially pensioners should not come close to dealing with CFD’s
How can CFD help in diversity of Investment?
CFD’s can be a perfect investment for the serious Investor. Let me explain.
A good Investor is the one who follows Buffet’s principles of Fundamental Investing and focuses on a few stocks. But this can sometimes be a limited approach. Most people have tendencies to trade and a great way to use a portion of their money could be to trade CFD’s.
Trading CFD’s teach Investors of pricing trends and movements. This will make them a good trend analyst. Most trend analysts have a mantra which is “Trend is my best friend.” Trend analysis helps in finding out prices that would be of good value during Investing.
CFD’s give an extra option for the Risk averse who want to experiment with more risky asset classes and gives them an opportunity to make them a lot of money within a short span of time. A good Investor always diversifies and they diversify their Investment styles as well to understand the other side.
Disclaimer : Just like most Investment advice, it is better to do research on the different asset classes yourself and it is better to put in a small amount of money to start off, so that you do not burn your hands.
Article By Jon Ng