Part 1 - What is a CFD?
In the early 1990s a young banker called Brian Keelan of UBS Warburg hit upon the idea of bankrolling the cost of a bid by his client, Trafalgar House, for Northern Electric, by betting on a rise in utility share prices in the sector as a whole.
Although the wheeze was ultimately unsuccessful as far as this bid approach went, and created something of a stink among rival banks and regulators alike, it was the first time that Contracts For Difference (CFDs) had been used in a large takeover - and it helped to create an entire industry that is flourishing today.
CFDs have become a very popular way to trade in recent years. Based on equity swaps, they had the additional benefit of being traded on margin and being exempt of stamp duty.
They were initially used by hedge funds and institutional investors to hedge their exposure to stocks on the London Stock Exchange in a cost-effective way but in the late 1990s CFDs were then introduced to retail investors.
CFD trading has taken the world by storm in the last decade and has gone from being an institutional product to one that is heavily traded by the retail market. It is fast replacing traditional share trading as it offers a way to trade in a very flexible and cost-efficient way.
A Contract For Difference is an agreement to exchange the difference in value of a particular financial product between the time at which the contract is opened and the time at which it is closed.
CFD trading essentially allows you to trade on a huge range of markets, without physically purchasing the underlying instrument, and make a potential profit if the market goes down, as well as up.
They offer a flexible way to trade on thousands of financial markets. The concept is simple: the CFD provider quotes a price and you buy if you think the market is rising or sell if you expect it to fall.
For example, you could trade on the price of crude oil without actually purchasing barrels of oil, or on the price of a stock without buying or selling the share.
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