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CFD - Contracts for Differences arised in early 90-ies in London. The essence of CFD is in trading the price differences. CFD isn't associated with any ownership of the underlying asset, or any rights and obligations.
CFD on shares does not mean that we own a part of the company. CFD on commodity doesn't make us obliged to deliver or take delivery of the traded commodity. It could be said that CFD is only a kind of bet, whether the price of the selected asset will rise or fall. Number of CFDs that can be traded, is therefore theoretically unlimited.
CFD price is dependent on the underlying assets - CFDs for Google shares are dependent on the Google shares, CFD on commodity (eg. corn) is very dependent on the prices of corn itself etc.. Our profit or loss depends on the fact whether we went Long or Short with the CFDs. The next important thing is whether the price difference of the underlying asset rises or falls, from the moment we have bought or sold it. When we decide to exit the trade, we must settle the price differences between the enter and exit prices with our counterparty.
You can trade CFDs using leverage, as well. This means that you can control a much greater volume of the asset than you would be able just from your own funds. This means that your profits, as well as your losses are multiplied. Thanks to the leverage you also receive or pay an interest. If you sell a CFD, the interest is paid to you. If you buy it, you pay the interest.
In the trade the Broker often becomes your counterparty. As you may realize, it is not the best starting position when the broker trades against you. He has got some certain advantages compared to you. These advantages begin at entering the trade, yet. E.g. the CFD is agreed with a larger spread (the difference between Bid and Ask prices) compared to the usual Futures trading. You must first overcome this larger spread to be in a profit. There is a strong likelihood that if you trade CFD's in a short term, you will be in a loss. You should think and trade in terms of weeks and months, i.e. long-term, if you want to trade CFDs. Then you can make some profitable trades.
Use: CFD are widely used to hedge our trades. E.g. if you own some shares, while assuming that their value will fall, you need not sell the shares. Instead you can sell a certain amount of CFDs for this stock (that is called Shorting). If the price of your shares begins to fall, you are in a loss, but immediately earn the same money thanks to the CFDs shorting. If you are wrong and the price of the shares rises you make a loss from the CFDs, but on the other hand make profit from the shares.
Advantages: Simplicity and Liquidity.
Disadvantages: Large spread, which must first be overcome. And don't forget that you trade against your broker.
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