In forex trading or CFD trading, the financial term ‘contract for difference’ refers to the exchange of contracts on currencies that have been quoted on the Global Forex Market. Contracts for Difference (CFDs) are contracts exchanged between traders or between market participants, on the one hand, on the basis of varying rate of exchange of currencies.
This contract for difference allows traders to speculate on the movement of various currency pairs. CFDs are traded on the Over The Counter Bulletin Board (OTCBB) for contract for difference trading and are listed by derivative name on the OTCBB. CFDs are leveraged derivatives that enable traders to benefit from fluctuating market rates and are traded on futures exchanges, over the counter swap agreements and forward contracts.
In forex trading, a contract for difference essentially refers to a contract where the buyer pays the seller the difference in the value of the assets at contract closing, on the one hand. On the other hand, the sellers can also be the buyers in the contract for difference. CFDs allow the traders to use the price movements of the underlying assets as leverage; which means traders can use the movements of prices of the assets as additional funding for their positions. CFDs are leveraged contracts that allow the traders to benefit from fluctuating market rates and are traded on futures exchanges, over the counter swap agreements and forward contracts.
For example, if a trader wants to speculate on the movement of the GBP/USD pair in hopes of a reversal to go long (bullish) and short (bearish) the contract for difference would allow the trader to purchase CFDs that represent the value of the bond and that is convertible into the GBP/USD pair on the maturity date, thus covering the losses in case of a bull market.
On the other hand, CFD trading involves higher risks for the trader because the trading is done on margin and the CFD trader must pay the commission of the CFD market maker. The CFD trader also has to pay the spread, if there is any difference between the bid and ask price. CFDs are leveraged contracts and the CFD trader has to pay higher commission. In addition, the CFD trader may be required to provide credit facilities.