CFD Trading - what is it?

The abbreviation CFD stands for "contract for differenceprices. "It is a financial derivative that allows you to profit from the growth or fall of stock quotes.The trade in this instrument poses a huge danger to private investors.

Invention

Contracts for the difference prices first appeared inGreat Britain in the 90s of last century. In the early stages, they were a kind of stock swap, intended for margin trading. Their invention is attributed to Brian Kilan and John Wood, employees of the Swiss investment company UBS.

Initially contracts for the price differenceused by institutional traders to reduce costs when hedging open positions on the London Stock Exchange. The main advantages of the new derivative financial instrument were a small amount of collateral and no need to supply cash shares.

Small traders

In the late 90s of the last century, contracts forThe difference in prices was presented to private investors. Several British companies that developed innovative trading platforms took part in their promotion. New terminals allowed traders to monitor quotations and make transactions in real time.

Soon, small speculators realized that the mainthe advantage of contracts for the difference in prices is the ability to sell and buy any underlying asset using a large leverage. This fact was the impetus to the rapid growth of the popularity of CFDs. What did this mean in practice? How skillfully was this instrument used? CFD brokers quickly included in the list of available underlying assets stock indices, commodities, bonds and currency pairs.

Financial betting

Many notice the similarity of contracts to the differenceThe price with another derivative in the UK is a derivative instrument. Trade CFD has the same economic effect as the conclusion of financial wagers. This term refers to money rates for the change of any stock quotes. They are accepted by special organizations, working on the principle of bookmakers. In the UK, this type of activity is officially considered not a business, but a gamble.

Inevitable risks

Specificity of margin trading is the maina danger that lies in wait for buyers and sellers of CFDs. What it is? The use of a credit lever multiplies both profits and losses of participants in transactions. With marginal trading, market risk sometimes reaches a level that goes beyond common sense. A strong and rapid change in quotations can lead to the loss of all the funds of the investor.

The risk of counterparty default is alsoshould be taken into account when dealing with CFDs. What does it mean? Decentralized markets are characterized by an imperfect system of monitoring the adequacy of participants' funds. Even a profitable trade can bring a trader a loss in the event of the counterparty failing to fulfill its financial obligations. Therefore, this risk is typical for all off-exchange derivative financial instruments.

Comparison with other markets

There are types of exchange trade moretraditional than CFD. What are these markets and how do they differ from contracts for price differences? The most conservative and relatively safe are transactions with cash shares without the use of margin lending. They have very little in common with CFDs, since they imply a real change of owners of securities.

Much more risky are suchtools like futures and options. Transactions with them contain elements of rates on price changes and to some extent resemble the CFD trade. However, futures and options are traded on the organized exchange market, where the danger of non-fulfillment by the counterparty of its obligations is minimized. In addition, pre-determined expiration dates guarantee investors closure of positions even in the case of absolute illiquidity of instruments. Contracts for the difference in prices have an unlimited period of circulation, and termination of obligations for them occurs only after the conclusion of a mirror transaction. If there are no potential sellers or buyers in the market, closing positions may be a serious problem.

Availability and advertising

Contracts for the difference in prices are of interest forresidents of Western countries because of the small size of the minimum lot. Huge volumes of futures and options on American and British stock exchanges make them inaccessible to most private investors. On Russian trading floors this problem is completely absent. The minimum volume of fixed-term contracts on the Moscow stock exchange is one of the smallest in the world.

CFD brokers often hear accusations ofdishonest advertising. Usually information about the possibility of making a profit is accompanied by insufficiently detailed explanations of the inevitable risk. Some experts believe that trading contracts for the difference in prices is essentially the same as playing casino games.