While we are living in an era where we are enjoying the benefits of modern technology such as making friends, knowing people and sending or making money virtually- this could also be the best time for investments in the market.
Though investing appeared to happen even in the early era of 1800, it didn’t go “out of style.” But since modernization came, there was a new kind of trading platforms, tools, order types, processes and instruments established in the trading world.
Trading requires a lot of skills and understanding of the financial market. For you to be successful in trading, you have to learn the basics of trading, risk and money management and the trading instruments necessary.
Well, there are a lot of different trading instruments and some of those are Contract for Difference (CFD), Forward Contract, and Future Contracts, Credit Default Swap (CDS), Collateralized Loan Obligation (CLO) and a lot more.
Contract for Difference (CFD) and Future Contracts
In this article, we will only look at the difference between the two of the most used trading instruments at this point — Contract for Difference (CFD) and Future Contracts.
A Contract for Difference (CFD) is a contract that enables two parties, buyer and seller, to engage in a trade agreement on financial instruments based on the price difference between the current market value and the value when the contract ends.
Through the CFD, you can trade a wide range of assets such as foreign exchanges, stock shares and a lot more. This kind of derivative trading is widely used by most online trading platforms even if it has proven to be a potentially high-risk trading strategy.
The contract for Differences is commonly used by investors because it only requires you to invest a small percentage of the full value of the asset that you trade. A profit margin is necessary for this, though.
A profit margin is a financial ratio used to measure the percentage of profit a company produces from its total revenue.
Another trading instrument that is also known to many is Future Contracts. Futures are contracts that allow parties to engage in a transaction for a given asset at a predetermined future date and price. Here, the buyer must purchase or the seller must sell the underlying asset at the set price, regardless of the current market price at the expiration date.
This kind of trading instrument allows traders to lock in the price of the underlying asset. Futures are traded on exchanges where all contracts are standardized. This means that each contract has the same stipulation, regardless of who is buying or selling. It is mostly used in the commodities industry such as farmers, miners, and oil producers.
Contract for Difference (CFD) and Future Contracts: Pros and Cons
Well, every trading instrument has its pros and cons. You need to know its advantages and disadvantages before you decide on which one to use. So, let us breakdown some of the pros and cons of each trading instrument.
In CFD, one advantage of this kind of trading instrument is that it allows investors to easily take a long or short position or a buy and sell position. This provides investors with all of the benefits and risks of owning a security without actually owning it. While we see it as something good, there is a disadvantage in choosing this kind of trading instrument. The investor holds a losing position can get a margin call from their broker requiring the deposit of additional funds.
Like CFD, Future contract has its fair share of pros and cons, too. One advantage of the Future Contract is that companies can hedge the price of their raw materials or products they sell. This is done to protect them from adverse price movements. On the other hand, investing in futures contract might cause a company that hedged to miss out on favorable price movements.
To know which financial derivatives to invest in, you must know and understand the differences between CFD and Future Contract.
There are some notable differences between CFD and Future contract such as expiry dates, financing, and liquidity.
Both CFD and Future Contract can trade long and short and is tradeable on margin. They could be traded in different ways, too. CFD could be traded through an exchange like CBOT and CME while the Future contract could be traded via a counterparty which is your broker. In terms of the expiry date, CFD has generally no expiry date. The Future Contract has its expiry dates that could be monthly or quarterly depending on what is written in the contract.
Another distinct difference between CFD and Future contract is the availability of the market. CFD has a good and wide range of markets available for trading while there are fewer available markets when it comes to Future contract.
There are a lot more things to know about these two financial derivatives in the trading industry but having basic knowledge about CFD and Future Contract could help you in deciding which one are you going to invest in.