CFD stands for Contract for Difference. It’s a financial instrument designed to allow traders to deal in bulk commodities without having to make large purchases. The trader buys into a contract with the broker, based on the predicted price change of an underlying asset. The underlying asset is simply the product on which the CFD is purchased. It can be almost anything – most commonly, CFDs are sold on commodities, such as oil, gold, or coffee; stocks in individual companies; or stock indexes in the world’s major markets.
The CFD simply takes the place of a futures contract. To give an example, if you are interested in trading oil – which is now selling at about $43 per barrel – and you believe that the price will fall, you would purchase a CFD for a short position. If you believe that oil will increase, you would do the opposite and purchase a CFD for the long position.
With a CFD, the trader is taking out a contract with the broker that the asset will move in a predictable direction. If the price moves as the trader predicted, the CFD can be closed for a profit.
CFDs offer two main advantages to small traders: they are simple instruments, and they are available for a wide range of assets. Unlike futures or options purchases, CFDs have no expiration date, so that trader can choose when to close them. They can also be traded in much smaller lots than the underlying assets, making them good tools for small traders looking to enter a market.