What is a CFD?

A contract for difference or CFD, as it is commonly known, is a financial derivative that allows traders to speculate on the upward or downward movement in the value of a financial instrument – shares, indices, commodities or currencies.

According to ASIC, ‘CFDs are derivatives because their value is derived from the value of another asset, for example, a share, commodity or market index’.

Due to their complexity, CFDs aren’t suitable for everyone, so it’s worth considering your individual needs and circumstances and making sure you understand the risks involved before deciding to invest in them.

This video from the ASIC MoneySmart website provides insight to the types of risks that can be encountered when investing with CFDs.

How does a CFD work?

A CFD does not involve acquiring or owning the underlying asset that is the subject of the CFD.  The CFD only refers to any change in value of the asset.  The two parties who have entered into the contract stand to gain or lose depending on whether the value of the underlying asset increases or decreases.  The gain or loss is the difference between the opening price and the closing price of the contract, multiplied by the number of underlying shares or other assets mentioned in the contract.

Where can I trade CFDs?

The table below is a list of Australian providers offering CFD trading.
Canstar does not rate these providers for CFD trading capability.

Name Minimum Opening Deposit Major Trading Instruments Commission (ASX 200 Shares) Leverage – margin required Link to provider website
IG Markets $0 Indices
FX
Shares
Commodities
Cryptocurrency
ETPs
0.10% with $8 minimum From 0.5% – 5% Visit website
CMC Markets Forex
Indices
Cryptocurrencies
Commodities
Shares
Treasuries
From 0.10% or 2 cents per share for US/Canadian listed shares From 0.2% to 25% Visit website
Saxo Capital Markets AUD$3,000 Indices
FX
Shares
ETFs
0.10% with $8 minimum Up to 40x Visit website
City Index AUD$500 Indices
FX
Shares
ETFs
Commodities
0.08% with $5 minimum From 0.5% Visit website
TradeDirect365 $0 Indices
FX
Shares
Commodities
0.07% with $5 minimum Up to 200:1 Visit website
Halifax Online $0 Indices
FX
Shares
ETFs
Commodities
0.12% with $10 minimum Up to 200:1 Visit website
FP Markets From $1000 Indices
FX
Equities
Commodities
From 0.08% 100:1 as standard Forex Broker and CFD Provider – Australian Regulated
Plus500 AUD$100 Indices
FX
Shares
Commodities
Cryptocurrency
ETFs
No commission Up to 300:1 Visit website
Pepperstone US$200 Indices
FX
Commodities
Cryptocurrency
No commission Up to 200:1 Visit website

Who is the contract with?

The two parties in a contract for difference are known as the buyer and the seller. CFDs are typically traded over the counter (OTC) and this means the contract is directly between the two parties without an exchange. However, clearing houses are often used to facilitate the transaction.

When does the contract end?

CFDs do not have an expiry date and can be closed by either party generally at any time. That said, as with many types of investing, there can be occassions when it is not possible to close out a position or sell down an asset.

Trading parcel size

You can typically purchase CFDs in multiples of 1000s, and each CFD has its own price. Typically, the cash outlay is 5% of the value of the CFD. Therefore, the calculation of your initial outlay in this case would be: CFD price x number purchased x 5%.

What is leverage?

For a small outlay of cash, a CFD allows a trader to access a far greater level of exposure to the gain or the loss.
Leverage allows traders to deal in assets with a value that is typically far greater than the cash amount required to put the deal in place. In the case of CFDs, the cash required to put in place the contract is generally only 5% of the value of the contract. As ASIC explains, “the reason the initial cash outlay is only 5% is that “you are effectively borrowing the other 95%”. E.g. if you’re going long, a 10% drop in share price would equate to a 200% loss for you (excluding fees, interest and any other charges).”

CFD strategies

Two core strategies are used by CFD traders. These are known as:

  1. Going Long’ – let’s say for example, you believe Stock A will increase in value, you therefore want to buy a CFD for that stock. The counterparty to the contract is the seller and they believe Stock A will decrease in value.
  2. Going Short’ – essentially the opposite of going long. If you believe a stock will fall in value you would sell a CFD to a buyer who believes the stock will increase.

At the end of the contract, depending on the movement of the market valuation of the underlying asset, one party will owe the difference to the other.

Risks

There are a number of different risks to consider when trading CFDs, such as market risk, liquidity risk and counterparty risk. To learn more about common investment risks like these, check out this article.

CFDs are dependent on conditions in the market for the underlying asset, even though you are not actually trading the underlying asset. ASIC also says that you should only consider trading CFDs if:

  • you have extensive trading experience
  • you are used to trading in volatile market conditions, and
  • you can afford to lose all of, or more than (if you leverage your investment), the money you put in.