Contract for Differences – A Simple Explanation of CFD Trading

A CFD, or Contract for Differences, is a unique option for investors whereby the financial need to pay upfront for commodities isn’t required, in favour of a pre-determined payment under contract. This method of trading is becoming increasingly popular, but how does it work and why can it be so beneficial?

How Does CFD Work?

Where regular commodities and assets are typically traded for at specific times when they are required, CFDs are a form of contractual obligation that doesn’t need resolving instantaneously. What this means is that an asset can be observed for fluctuations by a potential trader and if they expect the market to drop in the near future, they can place a theoretical reservation, in turn allowing them to purchase the commodity when the time is right for them.

Much like with buying a car, if the demand is increased during a particular time of year, salesmen and women will undoubtedly raise the cost of the vehicle. During colder months however, or downturns in the economy, the demand can fall resulting in lower prices. Commodities work in the same way and up until the introduction of CFDs, a trader would have had to wait until the exact time and then purchase their new assets, while competing with others in their field that want to do the same.

Reserving an Asset

With a CFD, the contract will dictate when the asset should be purchased, theoretically allowing the investor to plan to purchase at the right time. Knowing when to do so takes time and data analysis, but when performed effectively, it can be possible to analyse the market, estimate how it may fluctuate in the future and then plan purchases for stocks, shares and other tradeable assets accordingly.

It’s this ability to reserve an asset or commodity that has become so prevalent within the trading industry. Rather than having to sit up late and wait for the value of an asset to drop to a desired price, market research can be performed, evaluations can be undertaken and the trader can simply make their contract with the vendor to purchase at the most beneficial time (when the price for the asset is lower, if research was done efficiently).

In Conclusion – Benefitting from the Investment

Although there’s no guarantee that the hard work will have paid off, if the research was successful and accurate, the end date of the contract will have aligned right when the market shifted, allowing the asset to have dropped in value. This means that the trader won’t just be purchasing their asset at a lower cost; they will have done so under contractual obligation, undercutting their competition in the process by reserving the commodities that they were considering.

CFDs may not be the be-all and end-all for traders looking for quick cash, but they are certainly a viable option for investors that want to eliminate the risk of commodities no longer being in stock, therefore reducing the need to compete by acting when the time is right.