Back again with Finex Glossary article.
This time, Finex discuss an instrument that you may rarely find, namely Contract for Difference or CFD for short.
What Are CFDs?
Contract for Difference (CFD) is a form of financial derivative contract between an investor and a CFD broker, in which the investor speculates on the price of a particular commodity or asset, whether it will rise or fall over the course of the contract.
If the price is higher at the end of the contract, CFD broker is obliged to pay the difference to the investor (aka profit). On the other hand, if the price is lower, the investor will have to pay the difference to CFD broker.
In CFD transactions, an investor is not actually trading or owning the commodity or asset, but rather betting on the future price of that commodity or asset.
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In the United States, CFDs cannot be traded by retail investors (individuals) because of regulations of the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC). In some countries, CFDs can be traded on registered over-the-counter (OTC) markets, such as the United Kingdom, Singapore, Hong Kong, Germany, and Switzerland.
CFD Regulation In Indonesia
CFD trading in Indonesia is under the authority of the Commodity Futures Trading Regulatory Agency (Bappebti).
Although there are no regulations specifically overseeing CFDs, CFD transactions are broadly covered by Bappebti Regulation No. 109/CoFTRA/PER/01/2014 on Derivative Contracts in Alternative Trading System. In accordance with the name of this regulation, CFDs are legally classified as derivative contracts traded in an alternative trading system (ATS).
The regulation further stipulates that CFDs can cover stock indices, foreign exchange markets, and commodity markets.
ATS involves bilateral trades conducted outside the futures exchange. Buying and selling of CFDs on ATS is specifically regulated in Bappebti Regulation No. 5 of 2017 on Alternative Trading System.
Based on this regulation, CFD transaction at ATS can only be carried out by “ATS organizers” and “ATS participants” who have permission from Bappebti.
It should also be noted that based on Bappebti Regulation No. 76 of 2009, foreign ATS (futures broker) participants are not allowed to conduct ATS transactions in the Indonesian market.
More About CFD
CFD transactions are generally carried out online. The trades are fast-paced and require close monitoring.
There are always two parties to a CFD, a “long position” (buyers) and a “short position” (seller). CFDs are offered by brokers who can act as one of the two parties.
CFDs can serve as instruments for traders to speculate on the short-term price direction of thousands of financial instruments, as well as money managers to protect their portfolio positions.
CFDs are “leveraged derivatives”. This means that investors only need to deposit 3.3% to 50% of the transaction value, depending on the size of the contract. CFD brokers lend balances to investors on interest terms. Learn how leverage works.
In various countries, CFDs are available for transactions in currencies, global financial indices, bonds, stocks, commodities, and cryptocurrencies.
How CFDs Work
CFDs are traded in the same units as the “ask” or “bid” price of the financial instrument used, depending on the trade. The bid price is the price you sell for.
For example, an investor buys 1,000 CFDs at an ask price of $10.00 to open a $10,000 CFD buy or long trade because they believe the price will go up. Margin rate set by CFD broker is 5%, so investors deposit $500. CFD broker lends investors a balance of $9,500.
If the bullish investor is right, and one-week later ABC’s stock offer rises to $10.50, the position is then $10,500 and the investor makes $500 profit on their $500 deposit—100% return.
On the other hand, what if investors think ABC stock is going down? Bearish investors can open short trades or sell them. For example, 1,000 units of CFD traded at a bid of $9.95 for a total of $9,950. In a short trade, the investor makes a 5% deposit or $497.50, and the account is credited with full value of the transaction or $9,950.
The $500 profit is a return of more than 100% on $497.50 deposit.
If the bullish investor is wrong about ABC’s bid and the bid price drops to $9.00, it means a loss of $1.0 00 for a $500 deposit.
How To Trade CFDs
Before you get into the world of CFDs, pay attention to the following points:
- Understand how CFD works
Completely learn the basics, and understand how they differ from other financial products
- Open a CFD account
If you are sure, we recommend starting with a demo account first. If you are trained, then you can enter the market directly.
- Choose the CFD market
Choose which market you want to enter.
- Decide to buy or sell
Click ‘buy’ if you think your market will increase in value, or ‘sell’ if you think your market will go down
- Choose your contract size
Choose how many CFDs to buy or sell.
- Add stop loss
Don’t forget a stop loss as an order to close your position at a certain price if it moves too far away from you. It’s an effective way to manage your risk.
- Monitor and close your transactions
When your position is open, you will see your profit/loss update in real time. You can exit by clicking the close trade button.
Open an account at Finex and enjoy the most popular trading platform, MetaTrader 4.