This section will go over the different kinds of CFDs available to traders. The different types of CFDs offered by brokers will vary by region, as regulations differ. The differences in the types of CFDs generally stem from the type of financial asset that is the subject of the contract. Some people find they need little else for their trading career, given the versatility and range of choices offered.
What Markets do CFDs Cover?
Contracts for differences can be traded on a vast range of different financial instruments, depending on the access that your CFD broker has to various underlying market price feeds and the range of markets available to trade is constantly expanding. The main CFD market types include:
- Global stock CFDs, examples. United Kingdom, USA, Asian and European
- Stock index CFDs, examples. FTSE, Dow, NASDAQ, NIKKEI, etc
- Forex CFDs
- Industry sector CFDs, examples. oil and gas, banks, technology, etc.
- Commodity CFDs like soft commodities and grains.
- Metals and energy CFDs, e.g. gold, silver, oil, natural gas, uranium…etc.
These contracts are the most commonly traded CFDs in the marketplace. In these types of contracts, the CFD price comes from the price of the underlying stock that is the subject of the CFD. For someone with experience trading stocks, trading share CFDs will feel exactly the same. However, there are some differences to be aware of.
As the name suggests, these types of CFDs are tied to the performance of a specific index. Traders prefer contracts based on index performance because of the high leverage possible, liquidity, and volatility these types of investments offer. Popular indices are the Dow Jones, NASDAQ, London Stock Exchange, Australian Stock Exchange, and Japan’s Nikkei. Those who trade indices believe that a specific market will rise as a whole. The advantages of index CFDs include the high trading volume, low margin, high leverage, low trading costs, and the access to international markets that would otherwise be difficult or costly.
Commodities are physical assets that are in demand. Investors classify commodities into two categories: hard commodities and soft. Simply put, hard commodities are mined and soft are grown. These assets are typically uniform in quality from one item to the next (this is known as a fungible good). For example, one soya bean is the probably the same as the next soya bean. Common commodities for CFDs include precious metals, corn, soya beans, wheat, gasoline, crude and heating oil. CFDs with commodities as the underlying asset give traders the opportunity to trade the futures market with the benefits of CFDs.
While trading commodities on an exchange is complicated due to varying lot sizes, different exchanges carrying different commodities, and expiry dates, the advantage of CFDs is they reduce the complexity of trading. Commodity CFDs can provide lower trading costs, and there is no confusion which exchanges to go to for specific commodities.
When a trader wants to speculate on the value of treasury notes, he or she would choose a treasury CFD. Treasury notes that are commonly traded include US Treasury Notes of varying years, US Bonds, Euro-Bund, and Australian Treasury Bonds.
CFDs allow you to profit wherever you find a growth area, regardless of where in the world it may be. As it is as easy to go short as long, you can also profit from a declining economic sector.
With sector CFDs you take an overall view of the economy, choosing for example healthcare as a solid growth industry. They save you having to analyze the individual companies, and you only need to see the big economic picture to select profitable areas to trade. With sector CFDs, you automatically have diversification, which reduces volatility compared with single stocks.
The only point to watch with sector CFDs is that they tend to have a bigger spread than do CFDs on individual stocks. If you’re considering a sector that is dominated by one or two large companies, it may well work out cheaper to trade CFDs on the individual companies rather than taking up the sector CFD.
UK traders now have the opportunity to profit from trading on inflation, as given by the monthly Consumer Price Index (CPI). This was only offered by one broker (GFT, which company has now been acquired by City Index), who also used to offer an inflation CFD on the European rate of inflation given by the Eurozone Harmonized Indices of Consumer Prices (HICP). The downside is that liquidity can be low..
The spread on these is about 0.1, and margin requirement 5%. You have a choice of going long or short on them. The CFDs are paid out on the basis of the initial published CPI figures, ignoring any subsequent revisions. If you’re concerned about rapidly increasing inflation devaluing your portfolio, you can use these CFDs as a hedge to avoid big losses.
Carbon Trading CFDs
Another very recent idea, and one that is both volatile and political, is a contract for difference with an underlier of the futures contract on emissions values. The carbon pollution program allows users to emit a certain amount of the gas, for which they get a permit. If they subsequently improve their performance (reducing the emissions) then they can sell their excess to others who need it.
The price of carbon emissions has varied from 8 to 30 Euros per ton in the last couple of years, with a typical value of about 13 Euros at the end of 2009. Incidentally, a VP at Shell recently estimated the actual cost to eliminate one ton of carbon dioxide is more like 72 Euros.
So with that as a background, Saxo Bank has launched a CFD product based on emissions futures. They require a minimum trade of 25 tonnes, and a 10% margin, which makes it a very reasonable trade, if somewhat hard to predict.