Derivatives trading can provide numerous opportunities of speculation in financial markets, without the need to possess underlying assets. The two methods that are commonplace and have differentiated features are contracts of difference and futures contracts. Knowing these cfd vs futures trading differences enables the traders to know the appropriate instrument to use.
The key differences and similarities between CFD and futures trading for beginners
What are CFDs and futures
Both CFDs and futures are derivative products that enable traders to make speculations on which the price of a good rises or falls without having to own the good. Nevertheless, the way they work is different regarding structure, regulation and trading mechanisms. The basic definitions of each instrument are as follows:
- Contracts for difference: Trader and broker agree to trade difference between the price of the asset at the opening and closing.
- Futures contracts: Standard contracts to sell or purchase an asset at a predetermined price on a specific date in the future.
- No ownership involved: The two instruments expose a person to prices without necessarily having to physically deliver the asset in question.
- Leverage is available: Both enable the operation of huge positions with the deposits in the form of rather small margins.
- Two-way trading: It is straightforward to gain profits in either a falling market or in a rising market with either of the instruments.
Similarities between CFDs and futures
CFD and futures have a few common characteristics that align them to be appealing to the active traders. The knowledge of these similarities assists novices to identify their similarities. The following are the major similarities of these two derivatives:
- Leverage trading: In both instruments, traders are in a position to trade large size with a small deposit in the form of margin.
- Hedging capabilities: Both will be able to hedge existing portfolios against negative price changes.
- Short selling allowed: Both CFD and futures products are easy to make profits when markets are falling.
- Global market access: The two offer international market exposure on indices, commodities and currencies.
- Speculative nature: Both are utilized in the purpose of trading as opposed to long-term investment.
Key differences between CFDs and futures
CFDs and futures have some fundamental differences despite similarities in which they are applied by traders. Such differences affect costs, flexibility and trading experience. These are the key distinctions novices are required to be aware of:
- Exchange trading: Futures in a regulated exchange whereas CFDs are over-the-counter trade as provided by brokers.
- Standardization of contracts: Futures are of consistent size contracts with definite expiry; CFDs allow the flexibility of position size.
- Expiration dates: Futures have to be closed or rolled over prior to expiry; CFDs do not have to be closed.
- Pricing transparency: Future prices in the open market; CFD prices based on underlying but determined by the broker.
- Cost structure: Future programs have commissions and exchange fees; CFDs have spreads and overnight financing fees.
CFDs vs futures which suits you more
The decision between futures and CFDs is based on the personal form of trading, funds and aim. Novices are supposed to look at their unique conditions in making the decision. The following are the factors to consider when making a decision:
- Account size consideration: Smaller accounts will find CFD flexibility desirable whereas larger accounts, possibly, will find future efficiency desirable.
- Market focus: The stock and forex traders mostly use CFDs, the commodity and index traders usual futures.
- Risk tolerance: Future has more regulatory protection and CFDs have more flexibility but has counterparty risk.
- Geographic location: There are countries that limit CFD trading and others with properly developed futures markets.
- Experience level: Newcomers would find CFDs more comfortable; more by beating around the bush, seasoned traders would admire the transparency of futures.
Frequently asked questions
Will I lose more than I give out in the CFDs or futures?
Yes, with both instruments leverage magnifies the losses and one can, in fact, lose more than one invested in the instruments.
What is the tax rate on profits of CFD and futures trading?
Tax treatment varies depending on the jurisdiction where the futures are based with the futures being given more desirable capital gains treatment.
Is it possible to trade CFDs and futures on the mobile platform?
The majority of the contemporary brokers have mobile trading systems that facilitate CFD and futures trading.
