CFDs and Futures are popular investment instruments that allow people to buy and sell assets with controlled risk easily. However, many investors are lost in differentiating CFDs trading and investing in futures.
This article explores the distinction between contracts for difference and futures trading. We will delve into the pros and cons of investing in these assets to give you a better understanding.
Futures and CFDs are similar products, but each offers different investing options. There are moments when it is better to invest in CFDs, but futures will be more compelling in others.
Now, let's get started.
A contract for difference (CFD) is a financial derivative instrument where the differences between open and closing trade prices determine the profit of the position. The investor doesn't have ownership of the physical good, product, or security.
While retail investors are not allowed to trade CFDs in the United States, it is available in most countries worldwide. The European Union, England, Cyprus, Australia, and Japan are just a few samples of jurisdictions that allow people to invest in Contracts for Difference.
CFDs represent assets in almost all investment markets. Leading brokers globally provide investors with contracts for differences in currencies, cryptocurrencies, sovereign debt, indices, and metals such as gold and silver.
Read more: What Is CFD Trading? Costs, Hours, Risks
The value of a contract for difference is determined by the difference between the opening and closing price of a trade and not ownership of the underlying asset. Therefore, you make money when you buy low and sell at a higher price, and vice versa.
Usually, when you go long or buy a currency pair, you speculate the price will go up. This means you will sell at a higher price. On the other hand, when you open a short position, you believe that the price will go down. In this case, you make money by purchasing the asset at a lower price.
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● Has no fixed expiration date
● Allows trading of currency pairs, ETFs, indexes, commodities, and futures.
● Allow the use of leverage to boost your profits.
● Easy to trade
● Often not traded on central exchanges
● Significant risks caused by wild price fluctuations
● Not allowed in the United States
● Require risk management skills
Please note: Margin FX and CFD trading carries a high level of risk and is not suitable for all investors. Please read the Risk Disclosure Statement before choosing to start trading.
A Futures contract is an agreement between two or more parties to purchase or sell an asset at a specific price on a set date in the future. It is called Futures because it is a contract that will be executed in the future.
Long story short, the buyer of a futures contract has an obligation to execute the underlying asset when the contract expires. On the other hand, the seller of the deal has the responsibility to provide the underlying asset at a specific date.
Futures contracts are presented in markets such as commodities, agricultural goods, energies, currencies, and indices.
There are two ways to use futures contracts: hedging and speculation. Hedgers use futures to protect themselves from losses emanating from adverse price changes. The hedger guarantees the current market prices. In other words, they lock current prices such that market volatility does not affect them.
Speculators bet on the future prices of an asset. For example, they go short if they believe the price is inflated and take a long trade if undervalued.
Speculators, mutual funds, and portfolio managers trade futures contracts to anticipate price movements on an underlying asset in the future.
Think about future contracts for oil. Crude producers set prices for oil barrels over the next year. So any oil contract spans 12 months. As such, they guarantee prices, production, and budgets.
Traders don't need the real goods to buy and sell futures contracts. As it happens with CFDs, futures contracts generate profits or losses from the difference between the opening and closing prices. However, traders must close the position before the expiration date.
Let's take an oil futures contract as an example. An investor purchases a December contract at $60 per barrel, which goes up to $70 due to geopolitical tensions in the Middle East. The trader sells the contract for $70 per barrel and makes 10 dollars per unit. Easy cake!
Futures contracts pros
● Futures are traded on central exchanges
● Standard contract size
● Fixed expiration date
● Low financial costs
● Producers can hedge and anticipate trends
● High risk
● Investors can lose more than invested
● Futures can make you lose more profitable short term trends
|Trading Types||mainly OTC trading||floor trading|
|Leverage||high leverage||high leverage|
|Expiry Date|| no||yes|
|Additional expense||yes (Overnight fee)||no|
Choosing between CFDs or futures contracts shouldn't be complicated. You only need to consider the features of each and choose an instrument that suits you.
Here is an example. While CFDs are traded in brokerages such as MiTrade, the transactions of futures contracts take place on exchange venues.
Overall, futures are more structured instruments that offer less flexibility. They respond to specific prices and real market flows, such as demand. In addition, futures offer products that are centralized in particular places or avenues.
On the other hand, CFDs are more flexible and allow you to trade the same size of futures contracts with less money. Also, with CFDs, you can keep your trade open as long as you want. The contrary happens with futures, as you should close your contract before the expiration date.
Another big difference between CFDs and futures is that futures contracts have significantly wider spreads. Also, futures work with bigger contract sizes. In contrast, CFDs allow more leverage.
That said, CFDs and futures share similar attributes, but as highlighted above, they have fundamental differences.
One of the most critical topics in trading is risk management. Regardless of the market, instrument, or strategy, you are using, you should control your trades with risk management.
Below are some helpful risk management tips and how to keep your trading leverage at decent levels.
Usually, professional forex traders use 100:1 leverage in their accounts. That means that they can control $100,000 with just a 1,000 investment.
For beginners, it is prudent to start practicing with a demo account and learn how to use leverage.
Seasoned traders with solid strategies and good trading plans can use higher leverages. But remember, the more leverage you use, the more you expose your account.
You should never risk more than 10% of your account balance in a single trade. Protect your account and diversify your positions.
Finally, accept bad trades, and cut the losing positions. Do not continue holding trades that are clearly on a losing streak.
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The content presented above, whether from a third party or not, is considered as general advice only. This article does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Mitrade does not represent that the information provided here is accurate, current or complete. For any information related to leverage or promotions, certain details may outdated so please refer to our trading platform for the latest details. *CFD trading carries a high level of risk and is not suitable for all investors. Please read the PDS before choosing to start trading.
Risk Warning: Trading may result in the loss of your entire capital. Trading OTC derivatives may not be suitable for everyone. Please consider our legal disclosure documents before using our services and ensure that you understand the risks involved. You do not own or have any interest in the underlying assets.