AndyMcGowan

Contracts For Difference (CFDs) allow you to make trades based on a number of underlying securities in many different markets. CFDs offer the benefit of being able to trade on the difference in the price of the underlying security between the opening and closing of the contract without having to actually engage in the complex process of purchasing and owning the security. Most CFD brokers, such as CMC Markets, offer CFDs across an extremely wide range of markets and underlying securities, though they all fall into the six major categories of either shares, indices, currency pairs, commodities, interest rates or bonds.

Which CFD Market Is Right for Me?

Choosing which markets to trade CFDs in depends on your knowledge and experience of these markets and their underlying securities. Below is an outline of these six major markets and their underlying securities to help you decide where to start trading CFDs.

Shares

A share represents a unit of account in the ownership of a financial entity, and denotes certain benefits and obligations that result from that ownership. When offering trading in CFDs based on shares, CFD brokers are referring to the classic equity shares in companies listed on the stock exchanges of certain nations. These exchanges are private entities that allow the shares of companies to be listed and traded according to the exchange rules and the applicable securities regulations of the hosting nation.

The listed value of a share on an exchange is generally the product of the future expected earnings of that company. Market participants purchase shares to own the value of these expected future returns. New information can change the estimations of the value of these shares, which will lead to either an appreciation or depreciation in value. With a CFD based on shares you can trade based on your expectation of these share price changes.

Indices

An index is just a basket of shares that is compiled in an attempt to represent the value of an exchange or some subsection of that exchange. For example, the famous Dow Jones Index represents a basket of the stocks of 30 of the largest companies on the New York Stock Exchange (NYSE). This index is often used as a measure of the performance of all of the listed shares on the NYSE, and is often used as a measure of overall economic performance in America or even the world as a whole.

In the end an index is just that, a basket of weighted assets based on some criteria determined by the person who compiles it. Whether it is the stocks of the 30 largest companies in America by asset value or the stocks of 10 medium-sized technology companies in South Africa, all indices are as representative of some larger whole as people want to believe they are.

However, people do trade indices based on financial instruments called ETFs (Exchange Traded Funds) that attempt to mirror the value of an index. Therefore, CFD brokers offer contracts on many major indices to match this market in index-based ETFs.  

Forex

Forex stand for foreign exchange, which is the market for different currencies traded between nations. Many individuals, groups and companies need to trade currencies to conduct their international affairs, and major banks and other financial institutions make markets for the exchange of currencies.

The forex market is based on currency pairs whose symbols will be familiar, such as GBP/USD (1 British Pound = X United States Dollars). The relative value of the pair will be based on the relative amount of demand for each countries’ currency by the other country, which is largely a product of the cross-border trade between the nations. CFD brokers offer contracts on all major currency pairs and a number of less common pairs as well.

Commodities

Commodity securities represent the actual ownership of a number of units of a denoted measure of an actual physical commodity, such as gold, oil or cocoa. The contract will specify a quantity, location and time of delivery for the actual physical good that the security is traded on. These commodity contracts are used by the suppliers and end-users (usually manufacturers) of the commodities to manage inventories and cash-flow.

What was once a smaller market based only on major global products like oil and precious metals has exploded with the globalization and digitization of the last half century. There are commodities contracts for an enormous range of goods, from soybean oils to pigs’ feet (Lean Hog Futures). CFD brokers offer contracts on a wide variety of these underlying commodity securities, and most will cover at least the major commodities, such as gold and oil.

Interest Rates

The financial markets are composed of a number of different interest rates representing numerous different markets for lending. You may be familiar with the most commonly-quoted interest rate the “prime rate”, which is the rate that banks use as a benchmark for their retail and commercial lending. All interest rates are ultimately intertwined, with increasing rates depending on the length of the lending contracts and the riskiness of the borrowers. Many CFD brokers offer contracts for these various interest rate benchmarks, where you can trade on their movements.

Bonds

Bonds are debt instruments where the borrower promises to make fixed payments according to the explicit terms of the bond contract. In addition, bonds offer the holders privileged access to the borrower’s assets in the event of a default. All manner of institutions offer bonds, from nations to cities and companies, and many of these bonds are openly traded on exchanges the same way stocks are.

The value of a bond traded on an exchange depends primarily on the value of the contracted amount (the principal or face value of the original amount borrowed), the terms of the contract (primarily the contracted rate of interest), the creditworthiness of the borrower, and the expectations for interest rate changes. When interest rates are expected to go down in the future, then the value of an existing bond with a fixed rate of higher interest goes up, as investors want to “lock in” this higher rate for the duration of the bond before the interest rate decreases in the future.

Trading in bonds is based on a keen awareness of interest rate projections and knowledge about the financial state of the original borrower. CFD brokers allow you to trade on price changes in a number of listed bonds without having to buy the actual bond itself.