Trading Contracts for Difference (CFD)

Contracts for Difference (CFDs)

A Contract for Difference (CFD) is a product which allows you to profit from the price movements of foreign stocks and indices without actually buying or selling them. This means that if you have bought a contract for difference (CFD) on ABC company shares, you do not actually acquire the corresponding number of shares but have the opportunity to gain from the difference between the buy and the sell price.

For instance, if Intel stock price is 30 USD and you believe that the stock is undervalued you buy a “contract for difference” on 150 Intel shares. In case that price rises by 1 USD to 31 USD you realize a profit of 150 USD. If the price drops to 29.50 USD you realize a loss of 75 USD.

Trading foreign indices is buying or selling these instruments so as to realize profit from changes in their levels. An index is composed of individual stocks and its level is determined as the weighted average of the prices of these stocks. The Dow Jones Industrial Average index is composed of the stocks of the 30 leading industrial companies in the US and the NASDAQ 100 index is composed of the stocks of the 100 most popular technological companies.

For example, if Dow Jones is currently at 8700 and you want to buy it, you should have at least 1305 USD in your account (margin amount is 15% of the index’s value). In case that the Dow Jones increases to 8900, you will realize a profit of 200 USD. And vice versa, if the index decreases to 8600 you will endure a loss of 100 USD.

Short Selling

Short sales give you the opportunity to gain not only when markets are up but when they are down as well. If you believe that stock or index prices will go down, you could sell the stock (index) now with the intention to realize profit by buying it at a lower price later. Short sales are closed by buying the same quantity of stocks or indices.

For instance, if Intel stock price is 30 USD and you believe that the stock is overvalued you short sell 100 shares at this price. Later, when stock price drops to 27 USD you buy the same number of shares thus closing your short position and realize a profit of 300 USD (3 USD per share). If price increases to 31 USD, you lose 100 USD (1 USD per share).

Although a contract for difference (CFD) is an instrument rather than an asset, it gives its holder certain rights which the holders of the base asset also have. These are the right of a dividend, splitting, merging shareholder capital. Contracts for difference do not give the right of ownership over the assets of a company, voting rights, and they are not transferable and are not traded on regulated markets. Market makers who offer these instruments have the right to close positions of their clients if they deem necessary, irrespective of whether the company has been declared bankrupt or not. “Contract for difference” deals are settled on the day they are concluded.