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Understanding the difference between a contract for difference (CFD) and shares of stock is very important for investors. Depending on the current condition of the stock market and the projected direction of that market, the focus of the CFD being essentially speculating based on the difference between the projections of two parties may be a good idea. At the same time, choosing to speculate on movement of individual stock offers may be safer, even if the potential for returns are not as spectacular. While not every nation allows the use of a contract for difference as part of the investment opportunities available, investors who live in the United Kingdom, France, Germany, and South Africa must often determine if more common forms of stock trading are in their best interests or if CFDs offer a better opportunity.
In order to understand how CFD and shares differ, it is important to define what is mean by a CFD, or contract for difference. As the name implies, the CFD is a contract between two parties, normally known as a buyer and a seller. Earnings are generated based on the movement in the prices of the stocks included in the contract from that start date to the end date. If that movement is upward, the buyer receives the return from the seller. Should the movement be downward, the buyer must pay the difference to the seller. A CFD can run for as long as the two parties determine, requiring only that a settlement is made based on the activity as of the date that both parties choose to end the arrangement.
This highlights the main difference between a CFD and shares, that shares in the CFD are purchased by individual investors who either realize a return if the price of those shares increases or experiences a loss if the price should fall below the original purchase price. Like the CFD, shares can be held for as long as desired. Unlike a contract for difference, the buyer or investor does not have to consult a partner in order to sell off the shares whenever he or she wishes. That means it is possible to quickly move forward with a sale if desired, without having to reach an agreement with a second party.
There are benefits to both a CFD and shares investing. It is not unusual for the returns of a contract for difference to be significantly higher than simply purchasing different investments. At the same time, the degree of risk associated with these contracts can be somewhat more pronounced, and may be somewhat daunting for some investors. This is especially true if the CFD was purchased on margin and the buyer ends up owing the seller a significant amount of money when the investment fails to generate an increase.
Not every nation provides a chance for investors to choose between a CFD and shares as part of an investment strategy. In some nations, like the United States, the contract for difference is not in harmony with current regulations that govern investment opportunities, making it illegal for US investors to utilize this type of investment vehicle. Other nations who have not allowed the CFD as an option previously are considering changes in policy that would allow contracts for difference to be traded in their countries. This serves to increase the need for investors to be more aware of the differences between a CFD and shares before they enter into that first contract for difference.