Trading CFDs and Futures. Table of Contents

In financial trading, two instruments that often surface in discussions among traders are Contracts for Difference (CFDs) and Futures. Each offers distinct advantages and presents certain challenges, thus making the choice between them dependent on the trader’s specific circumstances, goals, and available capital.

Which is Preferable for Trading Goods: CFDs or Futures?

Understanding CFDs

A Contract for Difference (CFD) is a financial derivative that allows traders to speculate on asset price movements, without the need to own the underlying asset. The contract is a private agreement between the client and the broker and pays out based on the price change between the opening and closing of the contract.

CFDs originated as tools for hedging against the UK’s stamp duty tax since they don’t involve the physical transfer of shares; thus, they don’t incur stamp duty. However, CFDs aren’t traded on exchanges and don’t involve a standardized contract, which means they lack the transparency and regulation that futures contracts offer.

Understanding Futures

Conversely, futures are standardized contracts that obligate the buyer to purchase, and the seller to sell, a specific commodity or financial instrument at a predetermined future date and price. Futures are traded on regulated exchanges, which means they are transparent and uniform across all traders and include legal protections that CFDs lack.

Key Features of CFDs and Futures Trading

  • Pricing and Cost Implications
    • Futures: Prices are set by the market and visible to all participants, ensuring transparency. The costs associated with trading futures are generally lower than those for CFDs due to regulated exchanges minimizing the spread and commissions.
    • CFDs: Prices are set by the CFD provider and can include wider spreads, which means trading costs might be higher compared to trading futures.
  • Market Regulation and Risk Management
    • Futures: Highly regulated by official bodies such as the NFA (National Futures Association) and the CFTC (Commodity Futures Trading Commission) in the United States, or the FCA (Financial Conduct Authority) in the United Kingdom, providing a structured and secure trading environment.
    • CFDs: Typically regulated by the brokers who offer them, except in the UK where they are regulated by the FCA. This can lead to potential conflicts of interest between the broker and the trader.
  • Investment Protection
    • Futures: Supported by clearinghouses that act as guarantors for trades, significantly mitigating counterparty risk. Trader funds are usually kept in segregated accounts, offering additional security.
    • CFDs: The security of funds can be less certain unless the broker is under strict regulatory oversight like in the UK. If a CFD provider goes bankrupt, recovering funds can be complicated.

Choosing the Best Market for Trade

Deciding whether to trade CFDs or futures should be based on your trading style, risk tolerance, and financial goals. Here’s how different types of traders might approach these markets:

  • Amateur Traders: May prefer CFDs for their lower initial capital requirements and flexibility. They provide a gentle introduction to trading but come with higher risk due to less regulation.
  • Semi-professional and Professional Traders: Often opt for futures because of the advantages of transparency, regulated trading costs, and more robust legal protections. These traders appreciate the ability to plan based on predictable costs and regulated market conditions.
  • Professional Investors: Typically use futures to take advantage of the standardized features and integral protections that are crucial for large-scale, strategic trades. Futures are beneficial for hedging against price movements in various commodities and financial instruments.

Both CFDs and futures offer useful opportunities for different trading strategies and objectives. CFDs provide flexibility and ease of access with lower deposit requirements, making them suitable for traders with less capital or those looking for quick market entry. Futures, being part of a regulated and transparent market system, appeal to traders and investors who prioritize stability, predictability, and the security of their capital. The choice between CFDs and futures should be made after careful consideration of one’s trading goals, experience level, and risk tolerance.