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What Are Contracts for Difference?

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  • Written By: Peter Hann
  • Edited By: Angela B.
  • Last Modified Date: 07 November 2016
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A contract for difference is a two-party contract to exchange the difference between an asset's value at the start of a contract and its value at the end of a contract. The asset to which the contract relates could be a currency, share, commodity or index. The payment made between the parties is equal to the difference in the price of the asset at the beginning and end of the contract period. Contracts for difference have risen in popularity, because they offer the opportunity for traders to take long or short positions and leverage their trades at a reasonable cost. By using contracts for difference, traders may benefit from asset price movements without needing to buy the underlying assets.

If a person buys a contract for difference when an asset price is $150 US Dollars (USD) and sells when the asset price is $200 USD, then that buyer receives payment of the $50 USD difference; if the asset price falls to $50 USD, then the buyer must pay the $100 USD difference. An investor engaging in contract for difference trading is not buying the underlying assets and may have to pay a deposit to the provider that amounts to a small part of the price of the underlying asset. This enables an investor to gain a sizeable market exposure with the possibility of larger gains or losses.

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Contracts for difference do not expire but are renewed by buyer's choice at the end of the trading day. A person may trade long by opening a position that will profit from an increase in price. The investor also may trade short by opening a sell position that would profit from a decrease in price.

The underlying assets for which contracts for difference are available include stocks, whole sectors, currencies, commodities and global indices. The price for entering or exiting contracts for difference is not subject to any restrictions. A position on a contract for difference may be closed at any time during the normal trading day by means of a second trade to reverse the original short or long position. Commission is payable both on opening and on closing a trade. Other than this, the particular broker may impose terms and conditions that vary from one broker to another.

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