Futures Trading and Contract for Difference (CFD) are 2 different products with similarities in that both offer high leverage to the trader. They are both highly leveraged derivatives that are based on underlying assets like index, currencies, equities, commodities and bonds. However there are 3 key differences between CFD trading and Futures trading. So what is the key difference?
There are 3 key differences between CFD and Futures Trading that traders should be aware of.
Expiry Date
While both CFD and futures trading allow the trader to participate in the movement of index, currencies, equities, commodities and bonds, future contracts has an expiry date. This stems from the original purpose of future trading which is a contract to deliver a product at a specific price and date. Most futures contract are traded and closed by traders before their expiry date as they never had intention to make or deliver the underlying product. For example, a trader that initiated a position to "buy" a futures contract for delivery of gold in 3 month's time may not actually want to receive gold. What he wants is to be able to sell off his futures contract within 3 months, at a higher price that when he bought.
CFD on the other hand has no expiry date. It is just a contract to pay or receive the difference in contract value between the time the contract is initiated, to the contract closure period.
Contract Size
Future contracts tend to be large valued contracts traded through major exchanges. There is a minimum contract size and the market participants are usually large institutional players. It is usually harder for individual retail investors to participate in futures contract as a minimum contract size is required. For example, a typical gold futures contract is 100 oz or approximately USD 165,000 at current market value. Even with 10 times leverage, a trader would need to have USD 16, 500 to trade in a single futures contract.
With CFD, the trader has more options. Most CFD brokers allow a much small trade size. The trader would be able to manage his risk better, and avoid a single large draw down to his capital with CFD.
Financing Cost
Both Future Trading and CFD incur financing cost in return for the leverage. However the way in which the cost is incurred is different. For a futures contract, the financing cost is priced in. For a CFD, the interest is charged on a daily basis. As CFD is typically for short term trading and involves a smaller contract size, the financing cost would be less of an issue although if required, the trader can choose to hold the CFD contract for a longer period (for example, if he is optimistic about the underlying asset, or if he wishes to give the trade more time).
In summary, CFD offer traders a hassle free and flexible way to participate in commodities, currencies or derivatives. Unlike for futures, CFD has no expiry date. The trader is also able to fine tune his trading position for each trade. This allows retail investors to practice a tighter risk management than is possible with trading futures contracts.
