With retail investors accounting for an ever-increasing portion of day-to-day stock and forex trading, more and more amateur traders are encountering the intricate machinery of the markets. There is far more to trading than the simple sale and purchase of stock holdings. More complex processes and instruments, chiefly CFD and futures trading, enable investors to engage with the market in unique ways, with the opportunity to realise gains via market speculation. But what are the differences between the two mechanisms?
What is CFD Trading?
CFD stands for Contract For Difference, referring to a contract made between the trader and their broker that governs the payment of difference in value of a given asset over time. In essence, CFD trading allows you to speculate on the price of an asset without requiring ownership of the asset in question.
If you believe a stock or currency will gain value over the course of the day, you can initiate a CFD buy order, and hold it until the asset does rise. Selling your CFD then pockets you the difference in value between the asset’s value at the point of CFD purchase and at the point of sale. The inverse is also possible, where you initiate a CFD sell order on an asset you predict will decrease in value, before buying out your deficit to close your position at a later date.
What is Futures Trading?
Similar to CFD trading, futures trading describes the act of speculating the price of an asset at a future date. However, futures trading differs significantly in that a futures contract legally obliges the sale or purchase of a given asset by a specific date. Price fluctuations are written into the contract on a daily basis, immediately crediting or debiting the accounts of the traders and brokers involved; the contract requires the sale or purchase of the assets under speculation by a specific date, but this can be circumvented by selling the contract before its delivery date.
The Pros and Cons of CFD Trading
One of the major advantages to CFD trading is that the underlying assets under speculation are not being traded; traders can profit from the movement of a stock without directly investing in the stock. CFD trading is also relatively flexible, and due to being a leveraged trade can be carried out for a fraction of its value.
The other side of the coin is that CFD trading is a risky endeavour, especially with leverage which can multiply in both directions. If a stock’s price goes down instead of up, you could be forced to cover losses well in excess of your initial investment.
The Pros and Cons of Futures Trading
Futures trading is a complicated process, but a transparent one. Contracts are clearly defined and easy to read, and profits are realised on a daily basis for the duration of the contract. However, futures trading is also a much higher-risk endeavour, often with much more equity on the line. They are also expensive to initiate, which tends to price out amateur investors in favour of established businesses.
