Before unravelling what a CFD is, you need to know what a derivative is, explains FSP Invest’s Ultimate Contracts for Difference Guide
A derivative is:
A contract whose value depends on (or derives from) the value of an underlying asset, reference rate or index.
What are CFDs?
Contracts for Difference (CFDs) are Over the Counter (OTC) derivatives. CFDs trade through “market makers,” not an exchange like the JSE.
These market makers create a market for CFDs to trade, and include banks and spread trading companies. They also provide liquidity to this market.
And unlike single stock futures where one contract is equal to one hundred underlying shares, one
CFD is equal to one underlying share.
The ins and outs of CFDs explained
A CFD trade is an arrangement between two parties to exchange the difference between the closing price of the contract and the opening price of the contract. The two parties involved are you, the trader, and the market maker.
The contract is based on an underlying equity or index.
The great thing is you’re not limited to South Africa to trade CFDs. You can trade international stocks and indices too.
There are more than two hundred CFDs available for you to trade. Commissions and fees vary between CFD trading companies, so research this before you start.
The difference in settlement between the opening and closing price of the contract are made through cash payments.
Trade CFDs long or short – It’s your choice!
With CFDs, you can go long or short, just like other derivative products.
When you go long, you hope the underlying asset (for example, the share) is going to rise so you profit from this upward movement.
When you go short, you believe the underlying asset is going to fall in value.
That’s the fantastic thing about CFDs, you profit from rises and falls in the market. But remember, this leads to losses if the market moves against your position.