Contracts for difference (CFD) are financial derivative products that are traded “Over the Counter.” They are very similar to exchange traded derivatives where you can speculate on rising or falling prices on securities such as equities, commodities, currencies, indices and treasuries etc. Since CFD’s are OTC products, they are bilateral contracts between a client and a broker where the client places bets on securities without owning the underlying asset, although prices closely track the value of the asset traded on an exchange. Since CFD brokers generally act as market makers, they hedge their risk by placing trades on the underlying asset traded on the corresponding exchange.
Example: If a client purchases 1000 CFD’s in Boeing, the broker will simultaneously hedge his short risk by purchasing an identical number of shares on the New York Stock Exchange where shares of Boeing (BA) are traded.
CFD’s are often compared to futures contracts traded on an exchange. Although there are quite a few positives, the negatives of CFD trading outsize the pros, atleast in the current regulatory environment. Highlighted below are some of the key pros and cons of trading in CFD’s