A CFD (Contract for Difference) is a popular class of derivative financial instruments among traders, allowing them to trade underlying assets like stocks, currency pairs, commodity futures, metals, energy, exchange-traded funds (ETFs), cryptocurrencies, and more, without owning them directly. Traders profit by betting on price changes, predicting whether the price of an asset will rise or fall, often using leverage, which boosts buying power without some of the limitations tied to trading the underlying assets.
Imagine you want to do one, or perhaps several, of the following:
All these, and many similar scenarios, usually require opening separate trading accounts – often one per asset class. You may need different brokers for stocks (1), futures contracts (2, 3, 4), forex (4), and crypto (5). In addition, you must learn the trading rules and mechanics specific to each asset, which vary by jurisdiction, broker, and asset type.
Trading underlying assets provides benefits such as transparency and oversight by regulatory authorities, which can help protect traders from losing money due to dishonest behavior by brokers or other counterparties, and also reduce the risks associated with leverage for retail traders with limited experience. Nevertheless, it also comes with certain features and limitations that should be taken into account.
For instance, trading stocks on the US market may come with restrictions like the Pattern Day Trader (PDT) rule, limiting you to no more than 4 trades per week for accounts under $25,000, high commissions from some brokers, inability to trade odd lots (lots not divisible by 100 shares), higher capital requirements for margin accounts, inability to short stocks on a cash account, unavailability of specific stocks for shorting at your broker, or delayed access to funds due to the T+2 settlement rule (i.e., two business days after the trade date). In the US, the most capitalized and liquid stock and futures market, brokers typically offer leverage of no more than 1:2 for stock trading with overnight positions, or none at all for cash accounts.
For futures trading, you’ll need to navigate broker selection, trading conditions, and commissions, as well as the mechanics of futures themselves. This can be more complex than it initially appears – consider contract rollovers (transferring positions to a new contract), minimum price tick, or rules for canceling or revising orders due to sudden price fluctuations (price gaps, local loss of liquidity, etc.).
In Forex, with limited capital, you’re unlikely to access the real interbank market or, in the best case, your orders will go to the local intra-bank market without the possibility of using leverage. And for cryptocurrencies, you’ll need to study the extensive trading conditions of various online-exchanges, their restrictions on short positions, and familiarize yourself with the process of opening and securing a crypto wallet.
Trading CFDs avoids many of these challenges. You have access to CFDs on stocks, futures, indices, gold, crude oil, currencies, and cryptocurrencies through a single platform and broker, with leverage up to 1:100, depending on the broker’s jurisdiction and trading conditions, no restrictions on long and short positions, the opportunity to use scalping and swing trading strategies, promt access to funds after closing a position, minimal or no commissions, and typically a free trading platform.
First, understand that you’re betting on price movements, and your broker is the counterparty. This means you don’t actually own the underlying asset – you only have a contract with the broker that reflects your position on price movements. While commissions may be absent, there could be a wider spread (the difference between the best bid and ask prices) and a swap fee (a charge for holding positions overnight). While you may have access to a free trading terminal or analytical platform, brokers may charge monthly or other service fees for software, leverage, or additional services like technical or analytical support. You should carefully review your broker’s trading terms and conditions carefully before you begin.
It’s also worth noting that CFD trading is banned in some countries by regulators.
For example, in the US, CFD trading is prohibited for retail investors, including citizens and residents, due to high leverage and the over-the-counter nature of CFDs. These rules are governed by the SEC (Securities and Exchange Commission) and CFTC (Commodity Futures Trading Commission), the primary regulatory bodies overseeing securities and derivatives markets in the United States. If you’re a US citizen or tax resident, please review these regulations or consult a lawyer.
Following the subprime mortgage and stock market crisis of 2008, the US enacted regulations prohibiting retail investors from trading CFDs due to the risks associated with high leverage and over-the-counter trading. The underlying motivation was to limit retail investors’ exposure to unregulated, highly leveraged markets that posed significant financial and systemic risks. US traders still can turn to alternatives like trading futures and options, exchange-traded funds (ETFs), including leveraged funds, or forex trading through CFTC-regulated brokers.
To comply with US laws, review materials on the SEC, FINRA, and CFTC websites or seek legal advice.
Happy trading! 🙂
