Contracts for Difference or CFD is emerging as one of the world's fastest-growing trading instruments. Starting in the UK in the 1990s (read History of CFD), it has been available in Singapore UK , Germany , Switzerland , Sweden , The
Netherlands, Italy , Norway ,
France , Ireland ,
Spain , Canada ,
South Africa , Japan ,
Hong Kong , Australia ,
Canada , New Zealand
and Singapore .
Basic
principles of CFD
A “Contract for Difference” is basically a contract agreeing to exchange the difference in value of a particular index,
commodity, stock or currency, between the time at which a contract is opened
and the time at which it is closed.
When trading via CFD, the trader does not
actually trade the actual underlying instrument through an exchange - what the
trader does is to initiate a contract between himself and the CFD broker
whereby he agrees to be paid (in the case of profit) or pay (in the case of a
loss) the difference in price when the contract is closed. When a CFD contract
is “closed out” – the difference in quantum of the instrument is calculated.
If the price moves in favour of the trader,
he would realise a real profit which equates to the price difference multiplied
by the quantity transacted. His trading account would be credited accordingly.
Conversely, if the difference is negative, the trader would realise a real
loss, and the CFD broker will debit this difference from the trader’s account.
An Example:
If you take a CFD trade to go long (i.e.
buy) on 200 shares of DBS at $11.80 and the price rises to $12.50,
then you profit from that change in price, just like you would from a
conventional stock broker.
Since you bought 200 units of DBS shares in
the Contract, your profit is:
($12.50 - $11.80) x 200 = $140,
excluding commission and financing cost.
The value of the CFD tracks the underlying
DBS share price, and if the underlying DBS stock move in your chosen direction, you can profit from the same change in price. The reverse applies if DBS stock moved against your chosen direction.
As mentioned before, you can easily short sell CFDs as well, and therefore profit from falling DBS prices.
As mentioned before, you can easily short sell CFDs as well, and therefore profit from falling DBS prices.
In
Summary
CFDs are traded on leverage to give traders
more trading power, flexibility and opportunities across a wide range of
financial products, all in a single platform. They are more suitable for
traders adopting swing or momentum trading strategies than "buy and hold" due to the additional financing cost. That being said, CFD is a tool and it is the trader that should decide how best to optimize his trading Returns given the various options available.
