Definition of CFD and It Compares With Trading In Futures

Financial markets have traditionally been associated with buying and selling of shares, a trading activity carried on in stock exchanges. However, the advent of the Internet and online trading platforms has been instrumental in the emergence of new products in the financial markets. The most recent trading instrument to make an appearance in the Australian financial market is CFD.

CFD is short for contract for difference. It is a contract wherein two parties agree to pay or receive on the basis of the difference between the opening and closing values of the contract. For example, let us suppose that a trader were to go long (buy) in the benchmark index of the Australian Securities Exchange, the S&P/ASX 200 at 4,335 and the trade at 4,348. The trader stands to receive 13 AUD from the trader who made the opposite short trade or sold the index.

It is an unlisted market, which means that trades are not routed through an exchange. Instead, CFD is an over-the-counter market just like the retail forex market. All trades are directly between the traders involved rather than being processed by a central clearing agency or an exchange. Just like the forex and futures markets, trading in CFD market is done using leverages. This allows traders to place trade of much higher value than the money in their trading account.

The margin requirements in CFD trading are often lower than the futures market of the underlying asset. For example, the margin requirement in ASX 200 in the futures market is AUD 430 as compared to AUD 13,750 in the futures market. Even after allowing for the difference in tick size and value of both, margin in CFD is still lower by AUD 3,000.