{"id":5185,"date":"2022-07-23T07:15:40","date_gmt":"2022-07-23T07:15:40","guid":{"rendered":"https:\/\/mdfinancialskills.org\/?p=5185"},"modified":"2023-06-05T17:43:44","modified_gmt":"2023-06-05T17:43:44","slug":"what-are-cfds","status":"publish","type":"post","link":"https:\/\/mdfinancialskills.org\/what-are-cfds\/","title":{"rendered":"What Are CFDs?"},"content":{"rendered":"\n<p>CFDs seem to be all the rage in the trading community these days. They\u2019re not exactly the new kid on the block, but thanks to a certain air of mystery (courtesy of US regulators) and more than a whiff of danger (via European regulators) CFDs are on a lot of traders\u2019 minds.&nbsp;<\/p>\n\n\n\n<p>Let\u2019s get to the bottom of one of the most risky but potentially rewarding financial instruments on the market today.<\/p>\n\n\n\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_64 counter-hierarchy ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<p class=\"ez-toc-title\">Table of Contents<\/p>\n<label for=\"ez-toc-cssicon-toggle-item-662881edc0b59\" class=\"ez-toc-cssicon-toggle-label\"><span class=\"\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #999;color:#999\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #999;color:#999\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/label><input type=\"checkbox\"  id=\"ez-toc-cssicon-toggle-item-662881edc0b59\" checked aria-label=\"Toggle\" \/><nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#What_Does_CFD_Stand_For\" title=\"What Does CFD Stand For?\">What Does CFD Stand For?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#How_Do_CFDs_Work\" title=\"How Do CFDs Work?\">How Do CFDs Work?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#What_Types_of_CFDs_Are_There\" title=\"What Types of CFDs Are There?\">What Types of CFDs Are There?<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Indices\" title=\"Indices\">Indices<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Forex_pairs\" title=\"Forex pairs\">Forex pairs<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Shares\" title=\"Shares\">Shares<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Cryptocurrencies\" title=\"Cryptocurrencies\">Cryptocurrencies<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Commodities\" title=\"Commodities\">Commodities<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-9\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#ETFs\" title=\"ETFs\">ETFs<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-10\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#What_Are_the_Costs_of_CFD_Trading\" title=\"What Are the Costs of CFD Trading?\">What Are the Costs of CFD Trading?<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-11\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Spreads\" title=\"Spreads\">Spreads<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-12\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Commissions\" title=\"Commissions\">Commissions<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-13\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Swap_rollover_fees\" title=\"Swap (rollover fees)\">Swap (rollover fees)<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-14\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#What_Are_the_Advantages_of_Trading_CFDs\" title=\"What Are the Advantages of Trading CFDs?\">What Are the Advantages of Trading CFDs?<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-15\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Leverage\" title=\"Leverage\">Leverage<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-16\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Ability_to_maximize_profits_CFDs_vs_stocks\" title=\"Ability to maximize profits (CFDs vs stocks)\">Ability to maximize profits (CFDs vs stocks)<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-17\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Ability_to_take_short_positions\" title=\"Ability to take short positions\">Ability to take short positions<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-18\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Hedging_with_CFDs\" title=\"Hedging with CFDs\">Hedging with CFDs<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-19\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Access_to_multiple_financial_markets\" title=\"Access to multiple financial markets\">Access to multiple financial markets<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-20\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#What_Are_the_Disadvantages_of_CFD_Trading\" title=\"What Are the Disadvantages of CFD Trading?\">What Are the Disadvantages of CFD Trading?<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-21\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Magnification_of_losses_CFDs_vs_shares_example\" title=\"Magnification of losses (CFDs vs shares example)\">Magnification of losses (CFDs vs shares example)<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-22\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Regional_restrictions\" title=\"Regional restrictions\">Regional restrictions<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-23\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Variable_costs\" title=\"Variable costs\">Variable costs<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-24\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Counterparty_risk\" title=\"Counterparty risk\">Counterparty risk<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-25\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Are_CFDs_Risky\" title=\"Are CFDs Risky?\">Are CFDs Risky?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-26\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Can_Americans_Trade_CFDs\" title=\"Can Americans Trade CFDs?\">Can Americans Trade CFDs?<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-27\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Why_cant_Americans_trade_CFDs\" title=\"Why can\u2019t Americans trade CFDs?\">Why can\u2019t Americans trade CFDs?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-28\" href=\"https:\/\/mdfinancialskills.org\/what-are-cfds\/#Conclusion_What_are_CFDs\" title=\"Conclusion: What are CFDs?\">Conclusion: What are CFDs?<\/a><\/li><\/ul><\/li><\/ul><\/nav><\/div>\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What_Does_CFD_Stand_For\"><\/span>What Does CFD Stand For?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>The acronym CFD is short for \u201ccontract for difference.\u201d What does that mean, exactly? A CFD is a <em>contract <\/em>between two parties stipulating that one will pay the other the <em>difference <\/em>in the price of an underlying asset from the moment the CFD was purchased to when it is sold.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"How_Do_CFDs_Work\"><\/span>How Do CFDs Work?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>A CFD is a type of derivative, meaning that the value of a CFD is based on the value of another asset. With CFDs, traders can bet on price movements of any number of underlying assets without actually owning those assets.&nbsp;<\/p>\n\n\n\n<p>For instance, if you think Amazon stock is going to go up, you could, of course, simply buy shares of Amazon stock (AMZN). You could also buy a CFD that is based on the price movement of the Amazon stock. If Amazon\u2019s stock price goes up, your CFD will be more valuable, and you will still be making money without ever owning Amazon stock.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What_Types_of_CFDs_Are_There\"><\/span>What Types of CFDs Are There?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>As I just alluded to in the advantages section, there are CFDs for just about any financial market you can think of, and brokers are constantly adding to their CFD offerings.<\/p>\n\n\n\n<p>Here\u2019s the list of the most popular assets you can trade with CFDs:<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Indices\"><\/span>Indices<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Index CFDs are a great way to access global financial markets. Typical brokers offer CFDs for several US indices, including, of course, the Dow and S&amp;P 500, plus the NASDAQ 100, and a few others. You can also easily find index CFDs for major European markets, such as the IBEX 35 (Spain), DAX (Germany), and the FTSE 100 (UK), as well as indices that cover the overall European markets. Indices covering the markets in Japan, Hong Kong, and Singapore are also commonly offered.&nbsp;<\/p>\n\n\n\n<p>A really interesting class of index CFDs has emerged in the last few years centered around \u201cthematic indices.\u201d Thematic indices are made up of stocks grouped together by a particular theme or trend. A prime example is a green index, which groups together a number of companies that are leaders in green technologies. Other examples of thematic indices for which there are CFDs are cannabis, remote economy, Corona anti-virus, and a cryptocurrency index.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Forex_pairs\"><\/span>Forex pairs<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Forex pairs have long been among the most popular CFDs. You can\u2019t access as many pairs through CFD trading as you can if you are simply trading through the forex market, but there are still a number of options beyond just the major currency pairs.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Shares\"><\/span>Shares<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>You won\u2019t find CFDs for any obscure penny stocks, but there are still plenty of options for trading CFDs based on shares. The number of available stock CFDs varies widely from broker to broker. Some only offer a few CFDs for American blue-chip stocks, but others, such as Ava Trade, offer more than 700 options from markets all over the world.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Cryptocurrencies\"><\/span>Cryptocurrencies<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>As I\u2019m writing this, the crypto world is in disarray. Bitcoin has lost more than half of its value, and other cryptocurrencies have suffered a fate even worse. It might seem, therefore, that this is a bad time to trade crypto CFDs, but this is where the ability to easily take short positions is such a big advantage. Anyone who sold crypto CFDs at their height and closed their position at the nadir is currently wondering how many yachts are too many.<\/p>\n\n\n\n<p>Not all CFD brokers offer crypto CFDs, but you can still access the crypto market by trading crypto index CFDs or crypto ETF CFDs.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Commodities\"><\/span>Commodities<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>In a lot of ways, commodities may seem like the exact opposite of crypto, but there are CFDs for commodity markets as well. A lot of traders use futures contracts to access commodity markets, but CFDs are much simpler. Almost all CFD brokers offer CFDs for gold, oil and natural gas&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"ETFs\"><\/span>ETFs<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Exchange traded funds, or ETFs, are basically mutual funds that trade like stocks. Some ETFs act like indices and track the S&amp;P 500 or other indices, but there are also ETFs that have a more narrow scope, allowing you to trade different sectors, such as the energy or financial sector, or different market segments, such as emerging markets. There aren\u2019t a whole lot of ETF CFDs currently offered, but they\u2019re becoming more and more popular and I expect we\u2019ll see a lot more options in the future.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What_Are_the_Costs_of_CFD_Trading\"><\/span>What Are the Costs of CFD Trading?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>One of the reasons we are hearing so much about CFDs lately is that CFD providers are really pushing them. Why? Well, like with most derivatives, brokers make much more money selling them then they do just selling the underlying asset.<\/p>\n\n\n\n<p>Back to my AMZN example, a broker makes far less commission on a simple shares transaction than they would if you were to purchase an Amazon CFD. So, obviously, brokers push the CFDs instead.<\/p>\n\n\n\n<p>Brokers make the most of their CFD profits in three ways:<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Spreads\"><\/span>Spreads<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>This is where most CFD brokers make the bulk of their money. They sell CFDs at one price and buy them at another, keeping the difference. That difference is known as the spread.&nbsp;<\/p>\n\n\n\n<p>Spreads vary greatly from broker to broker and are also dependent on the underlying asset. This extreme variance makes it tough to generalize how much CFDs spread, but <a href=\"https:\/\/www.ig.com\/en\/cfd-trading\/charges-and-margins\" target=\"_blank\" rel=\"noopener\">the spreads at IG<\/a>, which happens to be my favorite forex broker, are pretty representative. IG\u2019s spreads start at a minimum of 0.6 points for forex pairs, 0.4 for indices, and .3 for commodities.&nbsp;<\/p>\n\n\n\n<p>The tricky thing about spreads is that they aren\u2019t constant. Spreads can vary widely during times of high market volatility. For instance, spreads for forex pairs will be higher around the release of key economic data.<\/p>\n\n\n\n<p>Forex broker Oanda has a <a href=\"https:\/\/www1.oanda.com\/forex-trading\/markets\/recent\" target=\"_blank\" rel=\"noopener\">great charting tool <\/a>that demonstrates how spreads change and react to different market conditions. Use the \u201cAsset Class\u201d drop down menu to select CFDs and you can see Oanda\u2019s historical spread data and how its spreads have reacted to changes in the market.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Commissions\"><\/span>Commissions<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>A lot of CFD brokers don\u2019t charge commissions at all, but some brokers charge commissions on CFDs covering shares. In these circumstances, your total trading costs are the commission plus the spread, although spreads are usually very small when a commission is charged.&nbsp;<\/p>\n\n\n\n<p>Commissions can be either a flat fee or a very low percentage of the total value of the trade.<\/p>\n\n\n\n<p>If you have yet to sign up with a broker, make sure you understand their fee structure for whichever CFDs you plan to trade.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Swap_rollover_fees\"><\/span>Swap (rollover fees)<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Brokers charge swap, also known as rollover fees, when traders leave a CFD contract open overnight. Since CFDs are highly leveraged, traders are essentially borrowing money when they purchase them. If you hold onto a CFD position for longer than a trading day, the broker will charge a certain level of interest for this \u201cloan.\u201d<\/p>\n\n\n\n<p>Rollover fees vary by the size of your position and which type of CFD you&#8217;re trading, but if you do plan on holding CFDs overnight, make sure you know how much you\u2019ll be charged.&nbsp;<\/p>\n\n\n\n<p>A lot of brokers offer swap-free accounts for traders who are prohibited from charging or paying interest due to religious reasons.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What_Are_the_Advantages_of_Trading_CFDs\"><\/span>What Are the Advantages of Trading CFDs?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>So why mess around with CFDs when you could just buy the asset itself? There are a number of reasons to go the CFD route, but the most obvious is that CFDs give you substantial leverage.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Leverage\"><\/span>Leverage<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>CFDs are a leveraged product. Trading a leveraged product allows you to drastically increase your buying power because you\u2019re only putting down a small percentage (known as the margin rate) of the capital that would otherwise be required. In other words, you can take large positions without putting too much money down.<\/p>\n\n\n\n<p>Forex CFDs, for example, often have a margin rate of 0.5%. That means you could take a $200,000 position on a currency with only a $1,000 investment. Obviously that can lead to enormous profits if you make the right bet, but if the market moves against you, you could be on the hook for well more than your original $1,000. Leverage can drastically magnify both gains and losses.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Ability_to_maximize_profits_CFDs_vs_stocks\"><\/span>Ability to maximize profits (CFDs vs stocks)<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Traders use leveraged products with the hopes of maximizing profits, so let\u2019s see how CFDs achieve that goal by comparing their performance to that of stocks.<\/p>\n\n\n\n<p>Let\u2019s say AMZN is trading at exactly $100 and (for simplicity\u2019s sake) we live in a world without spreads or commissions. If you want to invest $1,000, you can purchase 10 shares at $100 each. If the stock goes up to $110, you would profit $100. Not bad.<\/p>\n\n\n\n<p>Let\u2019s go through that scenario and buy AMZN CFDs instead. We\u2019ll set the margin rate at 10%, which is the current rate charged by IG, the world\u2019s #1 (by their own metrics) CFD provider.&nbsp;<\/p>\n\n\n\n<p>Thanks to the low 10% margin rate, your $1,000 can buy 100 CFDs, which are worth a total of $10,000. If the stock goes up to $110, you have 100 CFDs that are now worth $11,000. Your profits are $1,000.<\/p>\n\n\n\n<p>Behold the power of leverage! Thanks to the CFD\u2019s leverage, you achieved 10x the return on the same monetary investment.&nbsp;<\/p>\n\n\n\n<p>Of course, trades don\u2019t always go your way, so please also read the \u201cDisadvantages of CFDs\u201d section to see an example of a CFD trade that goes against you.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Ability_to_take_short_positions\"><\/span>Ability to take short positions<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>CFDs make it very simple to bet that an underlying asset will decrease in value. Depending on the asset you want to short, it can be a complicated process in which you actually have to borrow the asset in order to short it.&nbsp;<\/p>\n\n\n\n<p>With CFDs, you simply sell the CFD and buy it back when you want to unwind your position. Since CFD traders never own any actual assets, the process is exceedingly simple, and you can take advantage of rising or falling prices.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Hedging_with_CFDs\"><\/span>Hedging with CFDs<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>If you\u2019re long on a stock because you believe in its long-term prospects but foresee some short-term volatility, CFD trading can be part of a simple and effective hedging strategy. You can sell CFDs and take a short position for that stock to profit off any short-term price dips, but still maintain your long-term position.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Access_to_multiple_financial_markets\"><\/span>Access to multiple financial markets<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Once you understand the ins and outs of this unique financial instrument, you can trade CFDs with a variety of underlying assets. Brokers offer CFDs for forex pairs, indices, shares, commodities, treasuries, and even crypto.&nbsp;<\/p>\n\n\n\n<p>If you find a CFD broker you trust, you have access to global financial markets and any number of different underlying assets all from the same trading platform.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What_Are_the_Disadvantages_of_CFD_Trading\"><\/span>What Are the Disadvantages of CFD Trading?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Risk. CFD trading is an extremely risky pursuit for retail clients. I go into it a little more in the next section, but the bottom line is that more than two-thirds of all retail traders lose money when trading CFDs.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Magnification_of_losses_CFDs_vs_shares_example\"><\/span>Magnification of losses (CFDs vs shares example)<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>In the advantages section, I showed you how CFDs can significantly magnify profits. This is the main draw of CFDs. However, let\u2019s look at how they also magnify losses. Here\u2019s an example of a CFD trade that goes against you.<\/p>\n\n\n\n<p>Going back to the Amazon example, let\u2019s once again assume you have $1,000 to invest and again, for simplicity&#8217;s sake we will ignore spreads and commissions. AMZN is trading at $100 and there\u2019s a 10% margin rate. You\u2019re bullish on Amazon and want to take a long position. That means you can buy 100 CFDs with your $1,000. So you\u2019re buying 100 CFDs for $100 and opening up a $10,000 position.&nbsp;<\/p>\n\n\n\n<p>Unfortunately, Jeff Bezos\u2019 latest space expedition goes awry and Amazon\u2019s stock drops 20 points in the blink of an eye. You now have 100 CFDs that are worth only $80 a piece, meaning your position has dropped to $8000.&nbsp;<\/p>\n\n\n\n<p>Since you opened your position on margin with only $1,000, you\u2019ve now lost twice as much money as you had. Your account would be at \u2013$1,000 and your broker will come looking for that money you owe.<\/p>\n\n\n\n<p>There are tools to prevent such extreme losses, like stop-loss orders, which would automatically close your position once your trade has lost a certain amount of money, and some CFD brokers offer negative balance protection, which would close your account the minute your $1,000 deposit was gone. The point remains, however, that any time leverage is involved, losses can mount quickly and wipe away more than your initial investment.<\/p>\n\n\n\n<p>If you had just purchased $1,000 worth of AMZN stock, you would have purchased 10 shares. After a 20 point drop, you would have lost only $200 and lived to trade another day.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Regional_restrictions\"><\/span>Regional restrictions<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>CFDs are considered so risky that they are prohibited in the US, Hong Kong, and Brazil, and many other jurisdictions have placed various restrictions on them.&nbsp;<\/p>\n\n\n\n<p>Some examples of local laws, most of which are applied by other countries as well:<\/p>\n\n\n\n<ul>\n<li>In much of the EU, brokers must offer negative balance protection.&nbsp;<\/li>\n<\/ul>\n\n\n\n<ul>\n<li>In the UK, brokers are limited in how much leverage they can offer on CFD trades.<\/li>\n\n\n\n<li>In Canada, brokers must evaluate a client\u2019s investment knowledge before allowing them to purchase CFDs.<\/li>\n\n\n\n<li>In Australia, margin is limited and brokers must issue product disclosure statements.<\/li>\n<\/ul>\n\n\n\n<p>In many parts of the world, CFD trading is heavily regulated, so you have to see if they still make sense for you. If you\u2019re interested in CFDs strictly because of the leverage, for instance, make sure that you know the regulations governing margin in your country.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Variable_costs\"><\/span>Variable costs<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>CFDs are typically pretty cheap, but in times of high volatility, spreads can widen significantly. That means the sell price will be substantially higher than the buy price. If you\u2019re trying to buy in or unwind a position during rocky markets, the wide spreads can take a big chunk out of your profits or really exacerbate losses.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Counterparty_risk\"><\/span>Counterparty risk<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>In more traditional markets, you buy an asset, such as shares from another trader, through an exchange. Exchanges are highly regulated and insured, and there is very little, if any, counterparty risk.&nbsp;<\/p>\n\n\n\n<p>With CFDs, however, you\u2019re trading contracts over the counter with your CFD broker. Since the counterparty is the broker without any intermediary, you run the risk, however slight, of your broker going bankrupt without honoring the contract.<\/p>\n\n\n\n<p>Large brokers don\u2019t frequently go bankrupt, but it does happen. In 2011 MF Global, primarily known as a futures broker but also a CFD provider, went bankrupt. They lost billions of dollars of clients\u2019 money in the process, and although most client funds were eventually refunded through bankruptcy proceedings, it took years.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Are_CFDs_Risky\"><\/span>Are CFDs Risky?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Yes. CFDs are highly leveraged derivatives, meaning that they are complex financial instruments that can significantly magnify losses (as well as gains). The vast majority of those trading CFDs lose money.<\/p>\n\n\n\n<p>CFDs are so risky, in fact, that they are prohibited for American traders, and brokers that offer CFDs in other jurisdictions are often forced to include the following disclaimer: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.&nbsp;<\/p>\n\n\n\n<p>Many brokers are also required to publish what percentage of their retail investor accounts lose money. These figures vary from broker to broker, but when I compiled a list of statistics from 15 different CFD brokers, the lowest percentage of retail investors who failed was 67%. That\u2019s right, even at the broker that fared the best, two-thirds of those who opened a CFD trading account lost money.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Can_Americans_Trade_CFDs\"><\/span>Can Americans Trade CFDs?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Not legally. CFDs are banned under an amendment to the Commodity Exchange Act, which states that \u201c<a href=\"https:\/\/www.cftc.gov\/LawRegulation\/FederalRegister\/finalrules\/2020-11827.html\" target=\"_blank\" rel=\"noopener\">US retail persons are prohibited from entering such swaps unless they are offered on a designated exchange.<\/a>\u201d&nbsp;<\/p>\n\n\n\n<p>Some brokers pushed back, arguing that CFDs were not technically \u201cswaps\u201d but the CFTC definitively <a href=\"https:\/\/www.cftc.gov\/sites\/default\/files\/idc\/groups\/public\/@lrfederalregister\/documents\/file\/2012-18003a.pdf\" target=\"_blank\" rel=\"noopener\">included CFDs in this category in 2012.<\/a> This classification means that CFDs are only allowed if they are traded on a regulated exchange, which they are not.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Why_cant_Americans_trade_CFDs\"><\/span>Why can\u2019t Americans trade CFDs?<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>US regulators main issue with CFDs is the fact that they are not traded through a regulated exchange. Theoretically, if the Chicago Board of Trade or another regulated exchange began to offer CFDs, they could be legal in the US. Since all CFDs are currently offered over the counter, however, the CFTC views them as unregulated derivatives, which are prohibited.&nbsp;<\/p>\n\n\n\n<p>US regulators don\u2019t allow OTC derivatives for a number of reasons. One factor is they want to protect retail investors from murky, risky financial instruments, but OTC derivatives also make it very easy to skirt insider trading laws. For example, an Amazon executive is prohibited from buying AMZN stock without disclosing their purchase to the SEC, but they could easily buy Amazon CFDs from an offshore broker and profit from insider information.<\/p>\n\n\n\n<p>It\u2019s unlikely that a regulated US exchange will begin offering CFDs anytime soon. The <a href=\"https:\/\/www.asx.com.au\/documents\/resources\/module_2_How_do_ASX_Listed_CFDs_work.pdf?cfd_course_02_text\" target=\"_blank\" rel=\"noopener\">Australian Stock Exchange (ASX) offered CFDs for a few years<\/a>, but it didn\u2019t go well. Regulation always adds costs, and most traders were content to save money trading their CFDs over the counter. The ASX CFDs therefore suffered from low volume and a lack of liquidity.<\/p>\n\n\n\n<p>That said, CFD brokers are making so much money that I wouldn\u2019t be surprised if someone finds a way to bring them back to US traders.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Conclusion_What_are_CFDs\"><\/span>Conclusion: What are CFDs?<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>CFDs are, as the kids would say, \u201chaving a moment.\u201d They\u2019re everywhere. But don\u2019t mistake their ubiquity for safety. The risks of trading CFDs are significant, particularly for retail traders. More than two-thirds of all retail investor accounts lose money when trading CFDs.<br>A successful CFD trader is someone who <em>thoroughly<\/em> understands both the instrument and the underlying asset that they\u2019re trading. I hope this CFD FAQ helps further your understanding. Please leave a comment below if you have any more questions, and I\u2019ll answer them in short order.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>CFDs are an increasingly popular option for traders who love high risk\/high reward derivatives. This CFDs FAQ should answer all of your questions about this controversial security.<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[13],"tags":[],"featured_image_urls":{"full":"","thumbnail":"","medium":"","medium_large":"","large":"","1536x1536":"","2048x2048":""},"post_excerpt_stackable":"<p>CFDs are an increasingly popular option for traders who love high risk\/high reward derivatives. This CFDs FAQ should answer all of your questions about this controversial security.<\/p>\n","category_list":"<a href=\"https:\/\/mdfinancialskills.org\/category\/trading\/forex-trading\/\" rel=\"category tag\">Forex Trading<\/a>","author_info":{"name":"Michael Diamond","url":"https:\/\/mdfinancialskills.org\/author\/michael\/"},"comments_num":"0 comments","featured_image_urls_v2":{"full":"","thumbnail":"","medium":"","medium_large":"","large":"","1536x1536":"","2048x2048":""},"post_excerpt_stackable_v2":"<p>CFDs are an increasingly popular option for traders who love high risk\/high reward derivatives. This CFDs FAQ should answer all of your questions about this controversial security.<\/p>\n","category_list_v2":"<a href=\"https:\/\/mdfinancialskills.org\/category\/trading\/forex-trading\/\" rel=\"category tag\">Forex Trading<\/a>","author_info_v2":{"name":"Michael Diamond","url":"https:\/\/mdfinancialskills.org\/author\/michael\/"},"comments_num_v2":"0 comments","_links":{"self":[{"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/posts\/5185"}],"collection":[{"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/comments?post=5185"}],"version-history":[{"count":1,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/posts\/5185\/revisions"}],"predecessor-version":[{"id":6022,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/posts\/5185\/revisions\/6022"}],"wp:attachment":[{"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/media?parent=5185"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/categories?post=5185"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/tags?post=5185"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}