What Is a CFD in Forex?

Ekaterina Nutriakova
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CFD is an abbreviation of the phrase “contract for difference”. It is a contract between two parties where the seller and the buyer agree to exchange the difference in the value of a specific asset from the moment the contract was opened until the moment the contract was closed. CFD is an over-the-counter financial derivative which gives an exposure to the change in costs of such assets as an index and a stock. Trading CFDs, one has the opportunity to get profit on any market, either falling or growing. A trader can open positions in many different asset classes, including stocks, indices, currencies, commodities and cryptocurrencies.

As CFD provides an opportunity to trade notional sums much higher than a person has on their account it lets them to essentially grow capital.

Together with this CFD gives a trader all the advantages of trading securities, without practical obtaining them. These are:

  • absence of stamp duty,
  • greater access to financial markets (for example, to overseas and emerging markets),
  • short selling opportunity,
  • low entry threshold,
  • ability to trade with big leverage.

CFD also allows a trader to earn on shares traded at the New York Stock Exchange, where such large companies as Bank of America, General Electric Company, Intel Corporation, Johnson and Johnson, Coca-Cola Company, McDonald’s Corporation are listed.

The actual situation in the market not only influences whether a trader receives an income or a loss, but also determines its size. The longer the market rises, the higher your profit will be, and conversely, the longer the market declines, the greater your losses will be. The opposite rule applies if a trader is betting that the market will fall. The longer the market falls, the more profit they can get, and if the market grows, they will suffer a loss.

Most CFD trades don’t have expiry dates. If you want to close a position, you simply place a position with the same value, but in the opposite direction. However, some brokers may offer forward contracts for different commodities which expire at a certain time in the future.

CFD Example

For instance, if a trader buys a CFD at $5 then sells it at $7, they will receive the $2 difference. On the contrary, if a trader goes short and sells at $7 before buying back at $5, they pay the $2 difference.

CFD History

Despite the fact that the actual inventor of the CFD is still debated, there is a popular opinion (mentioned at Wikipedia as well) that it was originally developed in the beginning of 1990s in Great Britain and at first it was a sort of equity swap which was traded on margin. The development of the CFD concept is broadly credited to Brian Keelan and Jon Wood, two financial experts from UBS Warburg, a Swiss multinational investment bank and financial services company.

Much later the demand for CFDs increased when it was introduced to the Australian financial market in 2002. The CFD market in Australia grew rapidly, with some estimating about 40 000 active CFD traders in this country alone. Further, in 2007, as the addition to over-the-counter CFD, Australia became the very first country that offered CFD on an exchange.

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What is an equity in forex?
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