CFDs let you speculate on short-term market movements. Like foreign exchange rates, share prices, stock market index levels, cryptocurrency rates or other underlying assets. Most people lose money trading CFDs.
Your gain or loss depends on the price of the underlying asset when the contract starts and ends. If the price moves in your favour, the CFD provider pays you. If the price moves against your CFD position, you pay the provider.
What is CFD trading
A CFD is a derivative, which means its value is based on another asset, like a share or index. But, unlike shares, when you trade a CFD you don't own the underlying asset. Instead, you speculate on its price movement.
You agree to pay the difference in price of the underlying asset between when the contract opens and closes:
- if you 'buy' a CFD (a 'long trade'), you expect the value of the asset to increase
- if you 'sell' a CFD (a 'short trade'), you expect the value of the asset to fall
You pay transaction costs and other fees to the CFD provider.
A CFD contract is legally binding. If the market goes against you, the CFD provider:
- will ask you to pay extra money at short notice to keep your CFD position open (a 'margin call'). This may lead to further losses
- may close out your CFD, for whatever it's worth at the time. You may lose all the money you invested
CFD contracts are not all the same. Every CFD provider has their own terms and conditions. You rely on the provider to fulfil their obligations to you.
Look for details in the product disclosure statement (PDS) and terms and conditions.
There are restrictions on the sale of CFDs to retail investors in Australia.
Providers must:
- apply 'margin close-out protection', to end one or more open CFDs before all or most of the investment is lost
- limit retail client losses by providing 'negative balance protection', so they can never lose more than they invest
They must not:
- exceed specific leverage ratio limits, depending on the CFD asset class
- offer incentives to trade CFDs, such as trading credits and rebates, or 'free' gifts like iPads
Read more about ASIC’s CFD Product Intervention Order.
Why CFDs are high risk
CFDs are complex and high risk. Even experienced investors may struggle to understand the risks and complexities of trading CFDs.
Most retail clients lose money trading CFDs. Consider whether you can afford to lose your money.
Leverage can lead to large losses
CFD leverage is like trading with borrowed money. The deposit (or 'margin') you give to the provider is a small part of what you borrow to invest.
Leveraging and trading on margin is highly risky. A small price change against your CFD position can have a big effect on your trading returns or losses. You can quickly lose your entire investment.
For example, you may have to put up $5,000 (5%) for a $100,000 contract. This means you are borrowing the other 95%. A 5% change in the underlying asset price could mean you lose your $5,000.
Consumer protection may not apply with overseas CFD providers
CFD providers operating in Australia must have an Australian financial services (AFS) licence. Overseas CFD providers often don't hold an AFS licence, so consumer protection under Australian laws will not apply.
This means you will not have access to independent dispute resolution through the Australian Financial Complaints Authority (AFCA). If something goes wrong, you may not be able to get help.
If the overseas provider does not hold an AFS licence, it could be a scam.
Wholesale clients lose consumer protection
Some firms may try to classify you as a 'wholesale client', rather than a retail client. They could ask you to sign up to a 'pro-account' and describe the benefits.
But if you're a wholesale client, you:
- may not have 'negative balance protection' or 'margin close-out protection' on your CFD. So you could lose more than the amount you invest
- waive your right to use the CFD provider's internal dispute resolution service
- cannot get external dispute resolution through AFCA
- may not receive a product disclosure statement (PDS) or financial services guide for the CFD
- will not be assessed to see if you fit the licensee’s target market
To check how you are classified, read the PDS issued by the CFD provider.
How CFDs are distributed
Only a licensed CFD provider can issue CFDs to retail clients in Australia. That means your CFD contract is with the provider, and you pay them for the transaction.
An authorised representative or introducing broker can tell you about CFDs, but they cannot sell them to you directly:
- Authorised representative – arranges for a licensed CFD provider to issue CFDs to you
- Introducing broker – must be licensed or authorised by a licensee, and arranges for a licensed CFD provider to issue CFDs to you. They are typically paid a referral fee for your business by the CFD provider
Always check that the product is issued by a licensed CFD provider, by reading the PDS.
FAQs
A high-risk, leveraged derivative contract between a client and a CFD provider. CFDs let you speculate on short-term market movements, like foreign exchange rates, share prices, stock market index levels, cryptocurrency rates or other underlying assets.
Why is CFD banned in the US? ›
Why Are CFDs Illegal in the U.S.? CFDs are largely unregulated. They are products offered over-the-counter (OTC) rather than through exchanges. This places them out of the reach of the Security & Exchange Commission, which regulates the U.S. markets.
What is a contract for difference CFD model? ›
Key Takeaways. A contract for difference (CFD) is a financial contract that pays the difference in the settlement price between the open and closing trades. CFDs allow investors to trade the direction of securities over the very short term. CFDs are especially popular in FX and commodities products.
Is CFD trading legal in Australia? ›
CFD trading in Australia is popular – and legal – but there are a few restrictions in place to protect individuals, including how much leverage can be offered.
What is contract for difference CFD auctions? ›
CfD agreements are awarded via auction. The Department for Business, Energy and Industrial Strategy (BEIS) sets the overall policy and parameters of the auctions – such as the maximum strike price and energy production capacity. National Grid ESO runs the auction, and the LCCC then signs contracts with the winners.
Can I trade CFDs in the USA? ›
CFDs are illegal in the US because they are an over-the-counter (OTC) trading product. OTC trading products aren't listed on regulated exchanges like the New York Stock Exchange (NYSE), bypassing US regulatory bodies. However, US traders have alternatives such as forex, options and stocks.
Why is CFD so risky? ›
CFDs can be quite risky due to low industry regulation, potential lack of liquidity, and the need to maintain an adequate margin due to leveraged losses.
What is the cost of CFD for difference? ›
A Contract for Difference (CFD) refers to a contract that enables two parties to enter into an agreement to trade on financial instruments based on the price difference between the entry prices and closing prices.
What countries is CFD banned in? ›
CFDs are illegal in the US and Hong Kong but in other countries, they can be traded under strict regulations. In such countries as Austria, Cyprus, France, and Australia, CFD trading is legal but certain regulations are in place to protect the parties involved.
Is a contract for difference the same as a swap? ›
A contract for difference (CFD) is similar to a total rate of return swap except that payment only occurs once on the contract expiration date. A CFD may have a single stock, a basket of stocks, or an index as its underlying reference asset.
Research and analysis are probably the two key distinctions between CFD trading and gambling. Whereas CFD trading is heavily based on extensive monitoring of markets and understanding data, gambling is not.
Can you make a living from CFD trading? ›
with CFD Trading? The simple answer to this question is that yes, it's possible to make money with CFD trading. The long and more realistic answer is that you first need to hone your trading skills and have a lot of discipline, practice, and patience to do well in the market.
Is CFD tax free in Australia? ›
In most cases, CFDs are treated on revenue account rather than capital. This means your trading profits will be taxed as ordinary income and are not subject to capital gains tax (CGT).
How does contract for difference work? ›
CfD is a long-term contract between an electricity generator and Low Carbon Contracts Company (LCCC). The contract enables the generator to stabilise its revenues at a pre-agreed level (the Strike Price) for the duration of the contract. Under the CfD, payments can flow from LCCC to the generator, and vice versa.
Why are CFDs illegal in the US? ›
In the USA, the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) have taken a firm stance against CFD trading. The primary reasons for the ban are concerns over the lack of transparency and the risks associated with leveraged trading.
What is the strike price of a contract for difference? ›
The CfD is based on a difference between the market price and an agreed “strike price”. If the “strike price” is higher than a market price, the CfD Counterparty must pay renewable generator the difference between the “strike price” and the market price.
Why is Forex Trading not allowed in USA? ›
Forex Trading Restrictions and Prohibitions in the U.S.
This restriction is intended to minimize risk and volatility in the market and discourage excessive speculation.
What is the penalty for trading CFDs in the US? ›
The consequences of trading CFDs with an offshore broker as a US resident are as follows:You may be subject to fines. The CFTC can fine individuals up to $200,000 per violation for trading CFDs with an offshore broker. You may be denied access to US financial markets.
Why avoid CFD? ›
CFDs are highly leveraged
This becomes particularly evident in a volatile market, when adverse price movements are often sudden and unanticipated, leading to financial losses. Throw in leverage and all of a sudden, those losses become vastly bigger.
Where is CFD trading illegal? ›
CFDs are illegal in the US and Hong Kong but in other countries, they can be traded under strict regulations. In such countries as Austria, Cyprus, France, and Australia, CFD trading is legal but certain regulations are in place to protect the parties involved.
