CFD

What are "contracts for difference" (CFD)?

The basic idea behind CFDs is that they are contracts between two parties that stipulate that one party will pay the other the difference between the present value of an asset and its value at a future date.

A CFD offers a simple alternative to trading, which allows you to invest in financial assets by replicating point by point the changes in the price of the chosen asset. CFD trading is an order execution service that allows you to invest upwards or downwards on the price movement of an underlying asset without owning the security and with leverage. CFDs represent an efficient approach to investing in the financial markets. They have become extremely popular in many countries around the world.

A bit of history

Derived from futures and options, contracts for difference were originally developed in the early 1990s by the derivatives office at Smith New Court - a London-based brokerage firm that was acquired by Merrill Lynch in 1995 for £526,000,000.

The innovation is attributed to Mr Brian Keelan and Mr Jon Wood of UBS Warburg. CFDs emerged in the over-the-counter (OTC) swap market and have been used by institutions to hedge their exposure to equities using risk hedging strategies. Initially, trading CFDs allowed hedge funds to easily sell short on the London Stock Exchange with leverage, while benefiting from a stamp duty exemption.

With CFDs, institutional traders and hedge funds no longer needed to physically settle their shares, as in practice these contracts do not require delivery or receipt of the underlying instrument. In this way, these large investors were also able to avoid the tedious and sometimes costly process of borrowing shares when they wanted to sell short (the REPO rate).

Initially, the market makers on the exchange were the only market participants allowed to sell listed shares short. These market makers then offered CFDs as OTC products to institutional investors. Contracts for Difference were only available to large companies, but in the early 1990s they became popular with hedge funds who wanted to take advantage of the ups and downs of the stock market.

In the late 1990s, Contracts for Difference were offered to retail traders and the retail market by Intercommodities Gerrard & National Intercommodities (GNI - now part of the Man Group plc). GNI offered its clients CFD products and an innovative trading system that allowed private clients to trade via the Internet directly on the London Stock Exchange. The retail CFD trading market in the United Kingdom grew strongly as a result. Proprietary traders, fund managers and institutions were now able to trade directly on the London Stock Exchange with the same advantages as institutional traders.

A market survey carried out in January 2011 revealed that approximately €1.3 trillion of turnover in the UK is linked to CFD trading.

How does a CFD work?

CFDs are traded on a margin basis. As the trader never owns the underlying asset, there is no need to pay stamp duty in the countries where this is charged. The trader can open a buy or sell position with the same ease, based on a wide variety of financial instruments, such as equities, commodities, currencies, stock indices, cryptocurrency and others, which are usually available for the same broker via a trading platform. This saves time, avoids complications and offers the investor a wide range of markets from a single application. But the real advantage of CFDs is not that they allow traders to pay no taxes, but rather the leverage available to trade any underlying financial instrument.

In practice, in order to trade CFDs, the trader must have a trading account with a broker that offers this type of derivative financial instruments. In this case, the trader simply needs to open a buy or sell position via the trading platform offered by the company. As there is no fixed maturity date, the position remains open until the investor decides to close it. CFDs brokerage fees include Bid and Ask spreads, certain commissions that are sometimes charged and interest charged on long (buy) positions every day in the case that the position is held open for exactly more than one day (if the position remains open overnight after the market closes).

Why should I invest in CFDs?

CFDs have become very popular over the last few years and have grown from a mainly institutional financial product to one of the most widely traded among investors and traders of all types. As a result, CFDs have rapidly replaced other traditional forms of investment in financial markets, such as equities, due to their flexibility and relatively low costs.

For instance, when an investor buys shares via a traditional broker, he has to invest the full value of the transaction, but through CFDs, it is possible to obtain the same exposure with less capital invested.

This financial product essentially allows you to trade on most financial markets with a margin going from 1% to 10%. This is similar to borrowing to invest in the market, with the effect that gains and losses are multiplied by 10 (assuming a 10% margin requirement), since a 2% increase in the price of the underlying instrument corresponds to a 20% return on the initial investment. Similarly, the price of a CFD closely tracks the price of the underlying asset; in fact, it is difficult to see the difference. In this case, the trader does not have to pay capital tax, but he does have to pay interests on the amount of the loan. If he opens a position in a CFD based on a $100,000 share and the margin required is $5,000, he has to pay daily interest on the $95,000 borrowed.

Example of a CFD

Let's take the example of Apple stock. Suppose you want to buy 300 shares of Apple stock for $130 each; you would normally have to invest $39,000 in the transaction if you deal with a full-service broker. If we could sell the 300 shares for $135, we would make a profit of $1,500, which would represent a return of 3.9%.

However, using a Contract For Difference, we can buy 300 contracts on the stock with a 10% margin of only $3,900. This reduced cost is called the initial margin. If we closed the position at $135, the profit would also be $1,500, but in this case the return on investment would be 38.5%. But beware, as you've no doubt deduced, with CFDs there is also the possibility of incurring a significant capital loss if the market moves against the open position.

What is "leverage"?

Leverage is a concept that implies that with a relatively small investment, we can make profits (or incur losses) far greater than the amount invested. Leveraged products such as CFDs are simply a way of increasing our initial investment, so that we can control a larger position, by paying or investing only part of the total position. Under normal conditions, CFDs allow traders and investors to optimize their investments up to 20 times or more. For aggressive speculators with a higher risk tolerance, the possibility to optimize their investment is the greatest advantage of this financial product. Traders who invest directly in the stock market have to invest a high percentage of the capital required to complete the transaction, but with CFDs, the trader only has to deposit a much smaller percentage of the value of the transaction, called the margin. This margin requirement is used to protect the CFD issuer in the event that the trader's position is closed at a loss.

By taking a leverage of 1:20 for example, if we fully utilize the capital deposited in the account, we can potentially double or lose our money with a movement of only 5% of the price of the underlying asset. For this reason, CFDs should not be taken lightly. This means that the trader must choose the level of leverage carefully and risk only the money he can "afford to lose".

CFDs are aimed at people with the following profile :

  • They have sufficient resources to cover new payments, regardless of the underlying value of the short-term investment.
  • Ils ne sont ni avides, surendettés lorsqu’ils font leurs investissements.
  • They carefully research their investments, set goals and formulate realistic plans.

Leverage means that any profit or loss is magnified because the position we control and are exposed to is much larger than the amount of money involved in the transaction. More importantly, CFDs are for people who understand the difference between good and bad debt, and who are able to control their emotional peaks.

To understand the concept of leverage, we can use the following example :

Suppose we buy a house for €150,000 and we have a cash inflow of €50,000 while the rest of the payment is borrowed through a mortgage. Now suppose the value of the property is €200,000 and we decide to sell the house. In this case we obtain for the sale a total of €200,000 with which we pay the €100,000 loan and keep a profit of €100,000. In this way, we have obtained double our initial deposit thanks to the 33% increase in the value of the property.

The same principles apply to leveraged products. Leverage varies at Gravity Market depending on the underlying asset.

What is the margin of a trading account?

In the Forex market, the term "margin" refers to the amount of money required to open a position with leverage effect.

The ability to trade on margin is one of the most attractive features of trading, but at the same time, it represents the main risk for the trader. Margin trading allows Forex traders to trade on funds borrowed from Gravity Market.

CFD brokers usually have a minimum margin requirement of around 10%. This margin means that if a trader wants to open a CFD position worth €2000 with a 10% margin, then he only has to invest €200 of his own money to open the position. With CFDs, a trader does not have to invest the entire trade amount.

Of course, there is a positive and a negative side. The higher the level of debt, the greater the potential profits or losses. If the price of the underlying instrument moves against the CFD position, the trader will be responsible for paying losses that can be much larger than the initial margin deposited. The trader must remember that regardless of the margin he uses in his transactions, it is the percentage of decrease and increase in the price of the underlying asset that can result in the loss of the capital invested in a position and even the entire account.

A piece of advice : Of course, there is a positive and a negative side. The higher the level of debt, the greater the potential profits or losses. If the price of the underlying instrument moves against the CFD position, the trader will be responsible for paying losses that can be much larger than the initial margin deposited.

Examples of margin trading

The trader opens a €1000 position with a leverage of 1:10, the required coverage is 10%. The margin used is then €1000 /10 = €100.

This leaves €1000 - €100 = €900 of usable margin in the account.

This usable margin is the maximum amount that can be lost.

If the trader takes a position on a protective stop to avoid losing more than 3% of his capital, the usable margin to open further positions is €900 - (€1000 * 3%) = €870.

What is short selling?

Short selling, or what is called opening short positions, in the stock markets consists of selling a stock that the seller does not own. When you sell a stock, Gravity Market will lend you the stock. The shares are sold and the proceeds credited to your account. Sooner or later, you have to close the short position by buying back the same number of shares (called hedging, call covering) to return them to your broker. If the price falls, you can buy back the share at a lower price and make a profit on the difference. If the price of the shares rises, you have to buy them back at a higher price and you lose money. This is the principle of the contract for difference. 

With Gravity Market, you can short sell almost all available underlying assets: stock market indexes, commodities, precious metals, equities (coming soon), etc.

CFD, a hedging tool

Since their creation, CFDs have been increasingly used as hedging instruments, mainly by investors who have no interest in keeping their open positions in shares or other financial instruments for a certain period of time. Suppose, for example, we have an option that we cannot exercise for a certain period of time. We believe that the share price will rise to a value of €10, at which point it is likely to start to fall, although we are not entirely sure that this will happen. Therefore, one possibility is to protect ourselves from this possible price drop by taking a short position based on CFDs.

Thanks to their qualities, CFDs have become popular among hedge funds and until recently, managers could use them to hide their positions and investments in the market. However, due to changes in the laws of countries such as the United Kingdom, any investor who accumulates a share equal to or greater than 1% of a company's total value through the use of derivatives is required to make this announcement to the market.

This change has helped private investors and traders to track potential short sellers and speculators so that by following their footsteps, they can discover good trading opportunities, as they can get a fairly rough idea of where the price in the short to medium term might go depending on the volume of buying and selling transactions. A practice applied by some investment funds is to buy CFDs of a stock that they believe will rise due to news or an important event, which they then convert into shares once the news is made public. This transaction allows them to earn high profits from the sale of the shares produced by the conversion, which is done at a significant discount to the rise in market prices.

How does the conversion work? When a trader buys a CFD equivalent to 100 shares of a particular company, the broker buys shares of that company as a hedge. If the client wishes to convert the CFD into shares, he returns the CFD to the broker who then delivers the shares to him for a small commission.

As a result, the use of CFDs to hedge transactions with shares or other market assets has increased as the popularity of these financial derivatives has grown.

CFD Spreads

The spread is the difference between the bid and ask price. The fact that there is a spread means that when opening a position, the price must move a certain distance in our favour before we can even offset what was paid for the transaction. Gravity Market offers its clients a RAW Spread from 0 pip. For more details, click here.

What are the risks?

Many individual traders in the contracts for difference market overlook the risks associated with the instrument. CFDs offer many advantages for making money compared to other investments, but to invest successfully through CFDs, the speculator must be aware of the risks associated with this activity. Unfortunately, some unscrupulous traders minimize the risks in relation to the potential benefits. There are privileged investors who make a lot of money, but there are also many people who speculate with a margin account for the wrong reasons. They usually have insufficient trading capital.

CFDs allow the investor to hold shares without physically owning them. They have a bad reputation because traders can borrow to invest more money than they own. This is one of the main marketing arguments of stock brokerage companies, the leverage multiplies the gains. But sometimes in the euphoria of this discovery, novice investors pay little attention to the fact that they will inevitably have losing trades and losses are also multiplied. The problem is that these traders who start trading CFDs only think about the profits they can make and not the risks.

No one should trade CFDs without having experience of trading on margin in a demo account in order to gain the necessary knowledge to control the risks of trading leveraged derivatives.

Other risks are related to the trader's habits. For example, after a series of winning trades, some traders increase their position sizes and therefore risks due to overconfidence. This attitude is very common, as increasing leverage inevitably leads to losses. Beginners become aware at this point that it takes not only knowledge of financial markets and trading, but also a great deal of control over one's emotions, the psychology of the trader plays a very important role in trading results. A professional trader accepts his losses and profits, he has the ability to remain objective and realistic. The profit objectives of the professional trader are not excessive in relation to his capital, he calculates his profits over a long series of trades, his discipline is not influenced by series of losses or profits.

CFD trading carries a significant risk compared to equity trading on a traditional stock exchange and therefore it is not suitable for all investor profiles. Those considering opening a CFD account should consider the potential pitfalls of margin trading. The risk for the investor is to lose more than the amount of the initial investment. CFDs are intended for people who have risk capital or money they can afford to lose.

As Warren Buffet says "the risk is not knowing what you are doing". Derivatives were originally invented to limit risk, CFDs are only risky if they are abused. Furthermore, as with any financial product, the risks will be much higher for investors who don't take the time to understand the product.

Costs of trading CFDs

At Gravity Market, we charge a commission on each order, and we apply the same spread as the market.

For more information, click here.

CFD interest rates and financing fees (SWAP)

Forex swap (also called Forex rollover) is an interest paid by the online broker's client for open positions from one day to the next. This interest rate is applied to any nominal amount whose trading position is open for more than 24 hours. When you buy a Forex pair you commit to resell it on a "spot date". This exchange (swap) for a new day is the swap rate that is applied to our position.

The Forex swap will not be the same on EUR/USD and USD/CAD. In fact it varies according to several data :

  • The online broker
  • Type of position : purchase or sale
  • The traded instrument
  • The number of days the position is open
  • The nominal value of the position

The Forex swap rate is updated every Wednesday at Gravity Market and is calculated as follows :

  • Short-term amount in USD * Spot rate of the currency = Short-term amount of the currency
  • (Short-term amount in USD * Spot interest rate Next USD/36 000) + Short-term amount in USD = Long-term amount in USD
  • Short-term currency rate + swap pips = Long-term currency rate
  • Long-term amount in USD * Long-term currency rate = Long-term currency amount
  • Long-term currency amount - Short-term currency amount = Currency difference
  • Difference in quote/(Short-term currency amount/36,000) = Swap interest rate

The interest rate of the swap is given in USD per 10,000 units of currency. The Spot Next USD interest rate as well as the short- and long-term rates of the currency are determined by the prime brokers. Other elements to know :

  • The rates are given by the liquidity provider.
  • The rollover is calculated on the basis of the total value of a trade and not in relation to the margin used.
  • Banks are closed at weekends, but they continue to charge interest. Gravity Market therefore charges three days rollover on Wednesday evening at closing for positions held open over the weekend.

CFD trading order types

Market Order : This order allows you to take an immediate position at the market price.

Limit Order : the limit order is used to pre-determine a buy or sell price in order to choose the most favorable price at which you wish to take profits or take a position.

Stop Order : The stop order determines a maximum level of loss on a position if the market moves against you.

Guaranteed Stop Order : The Guaranteed Stop Order is subject to a premium, it ensures you a fixed price of execution even in the event of sudden market movements or a gap.

OCO Order (One cancels the other) : an OCO order is composed of 2 orders. If one of the two orders is executed, the other is automatically cancelled.

If Done order : the if Done order is a conditional order linked to another open order. It is executed if the condition of the current order (stop, limit or OCO) is fulfilled.

Importance of using stop-loss orders

Any speculator who has traded in Forex with CFDs or even stocks, has an idea of what stop loss orders are as a tool to reduce risk. A stop loss order allows you to close a position when the price reaches a certain predefined level. This means that even if the trader doesn't observe the price development in the market, the broker will automatically close the position, thus limiting losses if the price moves in the wrong direction.

The stop-loss order simply becomes a buy or sell order in the market when a predetermined price level is reached. In the case of a normal stop-loss order, if the price of the financial instrument reaches the predefined stop-loss level, the order is executed at the next available price. This means that in very volatile and fast-moving markets, the exit order can be executed at a price lower than our stop-loss price. In this case, the best we can hope for is that the broker can get the best price which is usually reasonably close to the level predefined by the stop-loss. It is for this reason that at Gravity Market we have a low VWAP (i.e. volume weighted price).

A guaranteed stop-loss order makes it possible to close a losing position precisely at the predefined price, regardless of market conditions, which is not always the case with non-guaranteed stop-loss orders.

The broker must buy/sell at the best available price and make up the difference if necessary, so the cost charged to the trader for this service is used to cover the difference. In this case, if the trader places a guaranteed stop-loss order, he is charged for its use when the position is closed, which means less profit even if the market has moved in his favor and the stop-loss has never been executed. Therefore, some traders only use them if the market is very volatile or if the price is subject to frequent price deviations. This type of market can include stocks with low trading volume and commodities, among others.

When trading in the market, we always try to maximize the number of winning trades while trying to minimize the number of losing trades, but the reality is that there are unfortunately too many variables that can influence prices in the market at any given time, so it is extremely complex to predict the outcome of a trade with reasonable certainty. Instead of trying to guess the right direction of the market all the time, it is better to try to focus on perfecting the things we have control over. It's about mastering money management.

Le VWAP

The VWAP (Volume-Weighted Average Price) is the price at which all orders have been executed, weighted by the volume of orders.
When we buy or sell a large volume of orders, there is no certainty that we will get all of our orders at the desired price. So to have a maximum chance of having a large volume of orders at the desired price, we must look to see if the broker has significant liquidity and therefore offers low VWAPs.
Note that the VWAP can also be used by traders as an intraday trend indicator (less than one day).

Taxation of CFD trading

From a tax standpoint, capital gains on CFDs made by private individuals within the management of their private assets are taxed from January 1, 2011 at a flat rate of 19% + 12.30% social security contributions. This represents a total of 31.30%.

Capital gains on CFDs are taxable from the first euro earned.

However, capital losses realized on CFDs can be carried forward for ten years and deducted from capital gains realized on shares or Sicav. The reciprocal is also valid.

How do I keep the balance of a CFD trading account?

When trading with CFDs, it is important to be careful with the trading account balance.

To do so, the trader must carefully analyze the volume of his transactions and the amount of risk on each transaction in relation to the capital balance of his account. Unlike stocks or other financial instruments in which the trader invests his money and waits for the right time to sell, CFDs work in a way that constantly changes the principal account balance because it is a leveraged product.

Lack of capital occurs when the account balance is less than the initial margin deposit required by the broker. If the account capital falls below the required margin, the trader receives a margin call from the broker who asks the trader to close his positions or deposit more money. If the trader ignores the warnings, the broker may decide on his own initiative that it is better to close the losing positions (Stop Out) for covering the losses.

Trading CFDs on stock indices

CFDs allow traders to trade flexibly with most of the world's stock market indices. This type of CFD offers speculators the opportunity to gain exposure to the market for a large number of stocks with a single trade. This allows the trader to trade a large set of shares from a specific country of his choice, such as the United States or the United Kingdom. For example, if you trade CFDs based on the FTSE index, this means that you are trading on the stock index made up of the most important UK stocks.

With index CFDs, the investor can speculate on the ups and downs of the economy of a particular country, making them very popular with individual traders. Using indices, it is possible to take a position based on an entire market without having to analyze the outlook for the shares of a particular company, which can be more complicated since information is not always available.

This type of CFD is therefore a good option for accessing and gaining exposure to foreign markets.

Stock market indices

For the novice trader, indices offer the advantage that there is relatively little to watch out for. Stock market indices are made up of the major stocks in a given market.

For example, we have the Dow Jones Industrial Average, which is the best known index in the United States. It is only made up of 30 companies, which seems to be surprising..

Other important indices are the FTSE 100 and FTSE 250 in the United Kingdom and the NIKKEI 225 in Japan.

Counterparty risks of CFD trading

As the name suggests, a CFD is a contract between two parties that allows investors to bet on the price performance of a stock, currency pair or stock index for example.

CFDs are derivatives, investors do not invest in the underlying issued by the CFD. They invest in a contract with an issuer.

Contracts for Difference (CFDs) are traded over-the-counter (OTC), which means that prices are created between investors and CFD providers, not on a centralized exchange.

With an OTC contract, both counterparties are obliged to take risks. If an investor defaults, he can harm all other customers who have positions with that derivative provider.

A counterparty is an entity or company on the other side of a financial transaction. When you buy or sell a CFD, the broker who issues the contract acts as your counterparty. A contract for difference must therefore be closed out with the counterparty that issued the contract. In addition to the broker, the trader is also exposed to risk from the CFD provider's counterparties such as other clients and the different brokerage firms that are used by the broker to hedge trades.

What are the advantages of a CFD?

  • Liquidity : CFD prices directly reflect what is happening in the underlying market. This means that CFDs provide access to liquidity in the underlying market, in addition to the liquidity offered by Gravity Market.
  • CFDs operate on a margin basis : CFDs are leveraged financial products, so the trader only needs to deposit a percentage, of the total value of the trade. This increases potential returns and market exposure. For a usually lower cost, the trader can earn 10 times or more on a trade due to the inherent leverage. This means a more efficient use of capital since there is no need to invest in the full value of the underlying asset.
  • Tax-efficient transactions : Leverage can also provide tax benefits since investment costs such as interest payments are generally tax deductible. In addition, instead of capitalizing a potentially taxable capital gain on a stock position, an investor can sell a CFD and thus control how the capital gain is obtained.
  • Low transaction costs : CFD trades are generally much less expensive than equity trades through a broker specializing in these financial assets. Furthermore, the additional cost of keeping a long CFD position open includes only the interest cost that the trader has to pay, whereas in the case of traditional stock trading, the investor has to pay a tax which in some countries is as high as 0.5% (stamp duty). In the case of CFDs, this tax is not levied because the underlying asset of the contract is not physically acquired.
  • Easy to trade long or short : this allows traders to profit just as easily from rising or falling markets. Because CFD trading is based on the price movement of a financial asset, and does not require that this asset be physically held. Selling transactions are as simple as buying and the mechanics are the same.
  • Trade in different financial markets from a single account : Gravity Market allows you to invest in all financial markets, gold, silver, oil, stock market indexes, raw materials, treasury bills, currencies, shares of the various stock exchanges (coming soon) etc. This offers traders the opportunity to diversify their operations and investments from a single trading account.
  • Ability to trade at any time : Gravity Market offers extended hours to its clients, which means that they can trade certain instruments or markets such as the FTSE and Dow even when the underlying market is closed.
  • Short positions receive interest : All open short CFD positions receive interest on a daily basis as long as the position remains open.
  • The investor can trade in any period of time : with CFDs, there is no fixed expiration date.
  • The size of the contract is not fixed : the trader can trade any volume, large or small.
  • Stop-loss orders and conditional orders can be placed easily : this means that the trader can use sophisticated and customized order types, for example if the market reaches a certain price, then you can open a buy position with a volume X, but only after 9:00 am. 
  • CFDs allow you to receive dividends on long positions : a CFD trader receives the dividends generated by the shares once they reach ex-dividend status (the ex-dividend date is the date that determines whether a person receives dividends, if they have the shares before that date, they receive generic dividends), rather than having to wait for the dividend payment date (sometimes a month later). At Gravity Market, if the trader holds a long position with an equity CFD for a long period of time, the payment of dividends helps to cover the financial expenses.
  • CFDs allow you to hedge investments in different financial instruments such as shares : the investor can hedge equity portfolios, for example with short positions based on individual shares, stock market indices or industry indices to avoid the direct sale of the acquired shares that make up the investment portfolio. In this way, an investor can use CFDs to hedge long positions in a given asset by taking advantage of any short-term price declines, thereby protecting his portfolio against any price decline that may occur in the asset and which may cause him to close his position earlier. CFDs can be used in the same way to hedge investments in other types of financial instruments.
  • Online account reports and daily reports : Trading accounts allow their clients to view daily reports and online reports so that the investor can get an accurate picture of what is happening on a daily basis with their CFD trades.

What are the disadvantages of a CFD?

  • Leverage can be a double-edged sword : margin trading can amplify potential gains, but it is important to remember that losses can also be amplified. Risk management techniques are therefore essential.
  • Trading CFDs is riskier than trading other financial instruments : although a trader does not need to deposit the full value of his investment through leverage, he can still lose his entire initial margin plus an additional amount if the market moves strongly against him, in which case the trader faces a margin call in which he is forced to either invest more money or close his positions with large losses. In the case of short positions, the investor is exposed to a potentially unlimited loss.
  • Ease of access and low capital requirements can lead to excessive activity : due to the ease of access to different markets and low capital requirements, traders may be incented to trade excessively, which can lead to heavy losses if care is not taken. A trader who trades too much may try to enter the market even under unfavorable conditions.
  • Inflexible leverage levels : Gravity Market sets the applicable margin level for each market. The trader must accept this level of leverage and try to design risk management strategies around these levels. Leverage can be modified if Gravity Market deems it necessary, so that if Gravity Market increases the margin required to open CFD positions, the trader may then have to deposit additional funds to prevent his positions from being closed out.
  • A trader who invests in Equity CFDs does not have the same rights as a shareholder : the investor does not physically own the underlying asset, so he does not have any of the rights that investors who acquire shares directly in the market have (no voting rights, for example).
  • Positions that remain open overnight are subject to funding costs : these costs consist of a daily charge based on the size of the contract and are calculated on the basis of Libor. Long positions that are kept open for long periods of time result in increasingly higher interest payments. The interest charged on long positions held for long periods (+6 months) can significantly reduce the efficiency of the return in many cases.
  • CFDs have a collateral requirement which means that open positions are "marked to market": this means that if a position moves against the trader, it reduces the balance in his account. If there is not enough balance or margin in the account to keep open positions that are causing losses, the trader will be subject to a margin call which need them to have to deposit additional funds or close the positions.
  • CFDs are OTC derivatives : for this reason the trader must understand that at no time does he own the underlying instrument on which the CFD is based, therefore he cannot transfer his position to another CFD broker.
  • Investors who open a short position in Equity CFDs may be required to pay the full value of the dividend : in case a trader holds a short position in Equity CFDs, open beyond the reference date (the date corresponding to 3 days after the dividend detachment date), he will be required to pay the full value of the dividend.

Conclusion

In conclusion, CFDs offer traders the great advantage of being able to trade with leverage in different financial markets in a way that other products and investment options do not, as they require very high initial capital. However, as mentioned above, there are some disadvantages. It is an instrument designed primarily for short-term trading or for hedging long-term investments, areas in which it has clear advantages over other financial instruments. Nevertheless, the leverage offered by CFDs can become a double-edged sword, especially if the market moves against the positions opened by the trader. CFDs are not suitable for people who tend to suffer from stress and do not like to take risks.

Generally speaking, it is important that the investor is aware of the advantages and disadvantages offered by CFDs before deciding objectively whether it is a financial product with characteristics that are adapted to his needs. If you are considering trading these instruments for the first time, you can learn without risk with a demo account to make your own opinion free of charge.

Gravity Market gives you the opportunity to create a demo account for free..

en_USEN
fr_FRFR en_USEN