For more than a decade, CFDs, or contracts-for-differences, have been one of the most popular forms of financial derivatives. These contracts are called ‘derivatives’ since their value is derived from the price of an underlying asset.
A contract for differences is the type of derivative that is used for insurance. It is a contract between two parties where one party, the “insurer,” is selling protection. They will pay the other party, the “insured,” if a specified event happens.
Most CFD traders in Germany probably trade shares and indices, but many other assets can be traded through this form of contract.
Brokers
Traditionally, around 90% to 95% of all CFD trades in Great Britain by British brokers on behalf of German clients. It was much easier for German banks to get licence to trade these derivatives when the UK regulator allowed them into its market in 2000. Meanwhile, following quota restrictions and other regulatory hurdles, the German regulator’s share in the CFD market has fallen to just 5% or less.
In addition, the benefit of using a UK broker that already had a licence and infrastructure put in place in Germany meant it was much easier for brokers to take on business from Germany than getting licences and setting up infrastructure in Germany before taking on clients.
Online access
These days it doesn’t matter whether traders use British or German brokers when trading CFDs because they are so easy to set up and access online. However, both types of brokers offer different benefits depending on precisely what type of trader you are looking for.
For people interested in the stock market, the use of Contracts for Difference (CFDs) can be a powerful investment tool. CFDs are financial instruments that enable traders to open a position on a price movement without physically buying or selling any of the traded assets.
Consequently, there is no need to deal with a broker and multiple exchanges. It means investors have more time to watch their investments and can benefit from increased flexibility in managing their portfolios. This article will look at how CFDs work and what they offer investors.
Contracts for Difference – A quick overview
Understanding how they work is essential for those new to trading using CFDs before deciding whether they are suitable for you.
To begin with, they are complex financial instruments, so there is a high learning curve before you can trade successfully. Investors need to understand the risk involved and ensure they have all relevant knowledge before committing any of their capital. New traders should look for some trading ideas on social trading networks, such as Saxo bank or ZuluTrade, to copy experienced traders’ investments.
Calculate your expected benefit When using CFDs, investors must realise they are taking on more risk than standard investments because profits are limited, but losses are not. They must explain how this may affect their investment portfolio over time and also assess the risks associated with it. Only an investor who can assume this risk should open a position with CFDs.
To profit or to lose?
However, a key benefit of trading using CFDs is that you can minimize your risk exposure by selecting investments that suit your personal preferences. If the asset price drops, you will be able to close half of your position at break-even and let the other half run, thus limiting your losses.
In contrast, when trading directly in the market, all of your money would be tied up until expiration if you had opened a long position, exposing you to the more potential downside. It means that investors have complete control over their risks when trading CFDs.
Bottom line
In summary, considering the learning curve and the risks involved, CFDs can be a suitable tool for investors looking to increase their portfolio yield while managing risk prudently. It is mainly the case when they are used in conjunction with other investment firms such as mutual funds or ETFs.
