{"id":143965,"date":"2022-10-27T12:27:26","date_gmt":"2022-10-27T06:57:26","guid":{"rendered":"https:\/\/www.regenesys.net\/reginsights\/?p=143965"},"modified":"2022-10-27T12:27:26","modified_gmt":"2022-10-27T06:57:26","slug":"contract-for-difference-cfds-for-beginners","status":"publish","type":"post","link":"https:\/\/www.regenesys.net\/reginsights\/contract-for-difference-cfds-for-beginners","title":{"rendered":"Contract for Difference (CFDs) for Beginners"},"content":{"rendered":"

In this week\u2019s article we continue our series on derivatives by looking at a very popular and widely used derivative, especially in South Africa, known as a Contract for Difference (CFD). Although this type of derivative can be used to hedge against downside risk, investors commonly use it to increase their exposure in the market, and therefore also their potential gains or losses.\u00a0<\/span><\/p>\n

Just as with all derivatives, CFDs also derive their value from the movement of an underlying asset. They allow traders to trade price movements without actually owning the underlying asset. CFDs are offered by brokers for instruments like equity, forex, indices and commodities to name a few.\u00a0<\/span><\/p>\n

How does a CFD work?<\/b><\/p>\n

A CFD contract allows the investor to make a bet on whether the price of the underlying will rise (in which case the investor will \u201cgo long\u201d) or fall (in which case the investor will go short). The investor will put down a deposit for trading a CFD, which is known as the deposit margin and is usually a percentage of between 5% and 20% of the position taken, depending on the broker. Margins serve as collateral for the broker since the remaining portion of the position is effectively borrowed from the broker to fund the position. In effect the CFD gives the investor a leveraged position, meaning they have exposure to an underlying asset, but without having to fund it in full.\u00a0<\/span><\/p>\n

If the price of the underlying moves in favour of the investor, meaning that the price of the underlying increases while the investor holds a long position, the seller of the CFD, usually the broker, will pay the investor the difference between the initial buy price and the new value of the asset. On the flip side, if the price of the underlying asset moves against the investor, they will be expected to pay the difference to the seller of the CFD contract.\u00a0<\/span><\/p>\n

In reality, the investor might not want to close the position immediately when the underlying asset\u2019s price doesn\u2019t move in their favour. In such a case the broker will give the investor a call asking them to pay a maintenance margin, which is commonly known as a margin call. If the investor can\u2019t pay this margin the broker has the right to close the position on behalf of the trader.\u00a0<\/span><\/p>\n

Although many investors trade CFDs as a daily short-term instrument, it does not have an expiry date and as such the position can be held indefinitely. When the investor keeps a CFD position open past the daily cut-off time they will be charged an overnight funding charge. This cost reflects the cost of the capital the broker has in effect lent the investor in order to open a leveraged trade and can be thought of as interest.\u00a0<\/span><\/p>\n

Advantages of CFDs<\/b><\/p>\n