CFD refers to contract for difference, a system of trading without actual physical ownership. The parties to the contract agree to exchange the difference between the current value of the contract and its value on its expiry. The asset may be a share, commodity, currency or index. The seller pays the difference to the buyer if the difference is positive. On the other hand, if the difference is negative, the buyer stands to lose money.
It is a derivative product that allows traders to speculate on price movements without having to own the underlying asset. It is a leveraged product, which means that traders have to put up only a small margin amount of the total value of the contract.
A CFD provider works on the same lines as a traditional broker who acts on behalf of an account holder. Providers do not carry any risk and hedge their positions in relation to their clients in the cash market. For example, if a client were to buy 10,000 CFDs of EUR/AUD, it means that the CFD provider has created a short position in the currency pair. He will simultaneously create a long position in the cash market to hedge the risk.
Since the CFD provider is hedging his bets, he is in a position to pass on any price movement to the client. This allows the CFD provider to offer the best cash market price. Transparent pricing that tracks the price movement of cash market without delay assures traders that there is no conflict of interest despite the fact that they and the provider are counterparties in the contract.
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