Contract For Difference markets (also known as CFDs) are derivatives markets that are based upon various underlying markets such as individual stocks, stock indices, and currencies (forex). CFDs originated in the UK, but are popular throughout Europe and Asia.
What Are CFDs?
Contract For Difference markets are a contract between two traders to pay and/or receive the difference between the buying and selling contract values. For example, a trader that enters a long CFD trade when the FTSE 100 stock index is at £4,000 and exits the trade when the FTSE 100 is at £4,500 will receive £500 in profit from the trader who entered the opposite trade (i.e. a short trade).
Contract For Difference markets are available as unlisted markets (i.e. they are not traded on an exchange) and as listed markets (i.e. they are traded on an exchange). The unlisted CFD markets are similar to the forex markets in that all trades are directly between the traders involved, whereas the listed markets are similar to futures markets in that all trades are processed by an exchange.
CFDs are traded using leverage and usually have lower margin requirements than the equivalent futures markets. For example, the margin requirement for the ASX 200 CFD market is AUD 430, compared to the margin requirement for the ASX 200 futures market which is AUD 13,750. While this difference appears huge, the tick size and value must be taken into account. The tick size and value for the ASX 200 CFD market are 0.1 and AUD 0.10 respectively, and the tick size and value for the ASX 200 futures market are 1 and AUD 25 respectively. This means that 25 CFD contracts would be required in order to equal the tick size and value of the futures market. So, the equivalent margin requirement for the ASX 200 CFD market is AUD 10,750 compared to AUD 13,750 for the ASX 200 futures market.
Contract For Difference markets are available in Europe and Asia, but not in the US due to SEC restrictions preventing them. In addition, US traders are not allowed to trade CFDs regardless of the CFD's location.
Listed CFDs are currently available on the Sydney Futures Exchange in Australia, and include CFDs that are based upon Australian Stock Exchange listed stocks, various stock indicies (from Europe, Asia, and the US), and various currencies. Both European and Asian exchanges have announced plans to offer listed CFDs.
Contract For Difference markets are traded like futures markets, with the exception that they do not expire. CFD markets can be charted directly, but as their profit and loss is directly related to their underlying market, it is preferable to chart the underlying market while making trades on the CFD market.
The CFDs that are offered by the Sydney Futures Exchange have different trading times depending upon their underlying market. For example, the CFDs that are based upon European stock indicies are open during European trading times, whereas the CFDs that are based upon currencies are open almost twenty-four hours per day.
The following are examples of some of the listed Contract For Difference markets (all of which are offered by the Sydney Futures Exchange):
- ANZ - Australia and New Zealand Banking Group
- CBA - Commonwealth Bank of Australia
- SGB - St. George Bank
- TEL - Telecom Corporation of New Zealand
- SPI - ASX200 stock index
- INDU - Dow Jones stock index
- Z - FTSE100 stock index (not yet active)
- EURUSD - Euro to USD exchange rate
- USDJPY - USD to Japanese Yen exchange rate