If the first trade is a buy or a long position, the second trade (which closes the open position) is a sell. If the opening trade was a sell or short position, the closing trade is a buy. The apparent advantages of cfd trading often hide the associated risks. The types of risk that are often overlooked are counterparty risk, market risk, client money risk and liquidity risk.
The counterparty is the firm that provides the asset in a financial transaction. When buying or selling a CFD, the only asset being traded is the contract issued by the CFD provider. This exposes the trader to the provider's other counterparties, including other clients with whom the CFD provider does business. The associated risk is that the counterparty will not meet its financial obligations.
CFD (Contract for Difference) FACT SHEET CFDs are relatively new. They were first traded in the early 1990s, compared to futures (1730s) and options (1973). CFDs were created by a London derivatives brokerage firm called Smith New Court, which was eventually acquired by Merrill Lynch. Economists Brian Keelan and Jon Wood played a major role in the invention of CFDs.
CFDs (Contract For Difference) are a derivative financial product, in that their value is derived through the value of another financial asset. CFDs allow you to trade prices, buy or sell without physically owning the underlying asset. Your CFD provider will act as a counterparty to a CFD trade - the financial firm with which the CFD account is opened - and so it is important to research the broker and ask certain questions before you open a CFD account and start trading. Depending on what you need from your CFD provider, you need to consider whether they have the CFD expertise you require in a broader product offering.
A trader invests in a CFD provided by a CFD provider for the diverse portfolio of trades he/she might be interested in, such as currencies, stocks, indices, etc. A contract for difference (CFD) is an agreement between an investor and a CFD broker to exchange the difference in value of a financial product (securities or derivatives) between the time of opening and closing of the contract. In this case, the CFD provider would pay the equivalent of the dividend to anyone holding a long position in the CFD and deduct the equivalent from anyone holding a short position. The prime broker of a hedge fund will act as a counterparty to the CFD, and will often hedge its own risk under the CFD (or its net risk under all CFDs held by its clients, long and short) by trading physical shares on the exchange.
This is also something that the Australian Stock Exchange, which promotes its CFDs traded on the Australian stock exchange, and some of the CFD providers, which promote direct market access products, have used to support their particular offering. The counter argument is that there are many cfd providers and the industry is very competitive with over twenty CFD providers in the UK alone. It is a well known fact that your CFD broker will play an important role in your successful journey to becoming a truly independent CFD trader. Despite all the convenience that CFDs provide to the trader, CFD providers or brokers also make their money from the trades that traders make with CFDs.
Compared to stock trading, CFD trading is much the same, except that when you trade a CFD you do not own the actual stock. The most common type of CFD is stocks, but there are also other CFDs on sectors, indices and other financial instruments such as commodities and treasuries. One thing to note with the cost of financing is that you have to pay it if you have long CFD positions, but you will be paid interest if you have short CFD trades. The number of CFD providers continues to grow and although this increases competition in terms of you being able to choose only the best cfd providers, it does mean that you have to do your homework.
In the context of CFD contracts, if the counterparty to a contract fails to meet its financial obligations, the CFD may have little or no value, regardless of the underlying instrument.