One of the fastest growing financial instruments in the last decade has been the CFD, or contract for difference, quietly fueling the rapid expansion of the online trading sector.
This is the financial instrument behind many of the online equity and forex trading platforms that have brought numerous investment opportunities to the masses.
These online platforms have been at the forefront of the financial technology revolution and are challenging traditional brokerages, according to a recent report from CNBC. But their fast uptake in the market is largely due to the flexibility allowed by the CFD and technology that allows linkages to real time prices.
A CFD is an agreement between a buyer and a seller to pay each other the difference between an asset’s opening and closing price. It allows people to invest in the movement of stocks and other assets without actually purchasing the stocks.
Originally developed in the early 1990s in London as an economical way for hedge funds to short sell the market while circumventing the stamp duty tax, CFDs are now behind the booming online trading market.
Rather than sell users actual shares in companies, many online trading platforms sell them CFDs, which mirror the losses and gains of the shares, but do not require as much capital outlay as actual equities and allow for much higher leverage.
The growing CFD trading market often allows people to put down only 2 percent of a transaction’s price. This makes it easier to enter CFD trading than day-trading of actual equities, for which the U.S. Securities and Exchange Commission requires a minimum cash account balance of $25,000. While this does entail risk, it also drastically lowers the barriers to entry. CFDs also often entail lower fees and commissions than investments in actual stocks.
In addition, the method allows people to invest in highly-priced shares, like those of Apple, in smaller increments, by buying CFD’s based on the shares for $25 each rather than the nearly $100 for an actual Apple share.
On most platforms the CFDs trade in real time, and investors’ experiences are similar to actually owning the stock, according to industry leader eToro.
So two decades after it was developed inside a London investment bank, the CFD is experiencing a surge of activity through its application in online trading, fueling the platforms that tout themselves as a more democratic alternative to traditional brokerages.