Comparison between CFDs and Futures

Contracts for Difference, or CFDs and Futures contracts are both increasingly popular instruments, traded extensively across global markets. While neither involves the trade of the underlying asset, both are derivative instruments which allow leverage, and consequently high trading returns. But what exactly are they, and how do they compare and differ as trading options?

What Are CFDs?

Contracts for Difference are agreements formed by the trader and a buyer/seller which denote a nominal value of a particular asset. If the trader believes the relevant asset or market will rise over time beyond the nominal value, he buys the contract. When the asset rises above the nominal value as forecast, the trader then sells the contract, locking in the difference in trading profit. The reverse is true with shorting a particular market or asset - the trader sells in the first instance to later buy, and pockets the difference. The nominal value is tied to the underlying price of the assets traded, and therefore fluctuates in accordance with market movements.

Unlike futures, CFDs are traded off-market, i.e. with brokers independent of the trading exchange. They tend to be lower cost than futures, and are thereby more accessible to smaller traders. CFDs are also not permitted for US residents, being outlawed by regulators across the pond.

What Are Futures?

Futures differ from CFDs in a number of key aspects, and tend to be favoured amongst institutional investors and more experienced traders rather than CFDs. Perhaps the main obvious difference is that futures contracts stipulate a date at which the final trade takes place - whether the trader is buying or selling, the difference will be locked in on the specified maturity date. Unlike CFDs, futures don't track the price of the underlying asset as closely, and are defined instead by the prices of the futures market for the particular instrument. This makes pricing and the trade costs involved less apparent than with CFDs, but for the trader with a solid grasp of what each instrument does and how they behave, it can be a particularly profitable option, and oftentimes preferable to trading CFDs.

It is also worth noting that liquidity in the futures market often poses problems for traders, given that exchange-traded futures require an exactly matching buyer/seller. This results in the market maker often being called to fulfill the order, and leads to higher pricing and commissions in futures contracts which can at eat into trading gains.

Futures and CFDs bear many similarities in style, but differ in key areas and are no doubt distinct instruments in their own right. Deciding which most suits you is a case of personal preference, and requires weighing up the pros and cons on both sides to determine the most attractive option.