In the world of trading, many terms may come across as confusing and daunting. CFD also known as a Contract for Difference is one of them. In this article, we will explore what a CFD is and the pros and cons associated with holding them.

With retail investors pouring into the market over the past few years, there have been plenty of instances where investors may end up investing in CFDs without even knowing it. It’s important to know the underlying asset types you are holding, and this is explained below.

What is CFD?

A Contract For Differences is a financial contract between the buyer and seller. In CFDs, the buyer pays the difference between the current asset value and asset value at the time of contract.

How exactly is it different to holding a stock?

CFDs vs stocks: a comparison

Properties	CFDs	Stock trading
Ownership	No	Yes
Leverage	Yes	No
Go Long and Short	Yes	Yes (but going short is more complicated)
Range of markets to trade	Multiple markets	Equities and ETFs
Costs of trading	Spread & Rollover (Holding Costs)	Commission
Trading hours	24-hours, 5 days a week	During Stock Exchange opening hours
Dividends	Yes via a cash adjustment	Yes
Losses	Losses can exceed deposits	Losses capped at amount invested
Voting rights	No	Yes

The investor, in this case, does not own the stock. The trader gets profit based on the price change in the asset. CFDs are used by advanced traders and traders make price assumptions as to whether the security price will rise or fall. This can be done without owning the asset. If an upward rise movement security price is assumed, the trader may purchase a CFD. If not, the trader may seek to sell an existing security.

Unlike, stocks where traders pay full price for each share for complete ownership over it.

Pros and Cons of CFDs

Advantages of CFDs	Disadvantages of CFDs
CFDs have higher leverage than the usual stock trading. This means CFD traders have greater potential for a higher return,	High risks in trading with CFDs. Increased leverage also means a greater risk of potential loss.
CFD trading is open 24 hours as opposed to the traditional stock market (limited to stock exchange hours)	The CFD market is relatively new, thus broker’s credentials may not be regulated.
CFD platforms provide access to international markets (See a list of platforms here)	CFD traders are required to pay the difference of the current asset value to the asset value at contract time. This means the profit is cut down and may face the risk of loss.
CFD broker platforms usually offer a variety of trading options. Such as stock, index, treasury, currency, sector, and commodity CFDs.

Who Should Buy a CFD and for What Purpose?

CFDs are generally targeted at more experienced traders. It also provides a better opportunity for day traders that can utilize leverage to trade assets. This reduces the need for buying and selling the same securities. It may also be advantageous to traders with short-term outlooks.

However, it is important to understand the risks associated with CFDs. Such as the magnifying of loss through leverage. CFDs are also banned in certain countries such as the United States.

If you want to start investing in CFDs, do your research, understand the risks, and pick your broker wisely.