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, explains Viv Govender, the analyst behind Index Trader
Four advantages of trading CFDs
There are many reasons why you should trade CFDs…
#1: Magnified returns
CFDs are a leveraged (geared) product. This means you’re fully exposed to price movements of the underlying asset without having to pay the full price.
Gearing is essentially the borrowing of funds to purchase a financial instrument. CFDs give you a magnified return from this small deposit or margin
when compared to investing directly in the underlying share.
#2: Make money even when markets go down – a world of short selling profits
A traditional stock market investor who invests in equities can only make money when shares go up. With CFDs, and other derivative instruments like futures, you can profit from the market regardless of the direction it’s moving in.
If you think the market is going up, you can buy into a position. This is known as “going long”.
If you think the market is going to go down, you can sell the position. This is known as “going short
” or “shorting”.
#3: Low trading costs
You’ll spend a fraction of the normal commission and brokerage
when entering a CFD trade versus a normal equity trade. And there‘s no stamp duty, VAT (depending on who you trade through), STT (securities transfer tax) or STRATE fees. And there’s no delivery of the physical asset either.
#4: No expiry date
In general, CFDs don’t have an expiry date. This is the key difference between CFDs and single stock futures, which expire every three months.
With futures you have to either exit your trade at expiry or roll over into the next quarter, but this involves additional charges. But remember, even though you can hold a CFD indefinitely, financing costs do add up over time.
So there you have it, four reasons why you should trade CFDs.