Understand The Difference Between CFDs And Futures
For new traders, contracts for difference (CFDs) and futures are occasionally confusing because of the general similarities between them. Both instruments are derivatives, they carry more or less similar leverage benefits. But this doesn’t mean that either of them can be authoritatively said to be superior to the other. While CFDs are commonly traded directly by brokers, futures are largely traded on an exchange. This is one of the most distinct differences. Another major difference between the two is their liquidity and mode of financing. Generally, CFDs are readily filled and with lower barriers compared to futures contracts. This post details the comparison of CFDs vs Futures based on various elements.
What are Futures Contracts?
They are primarily exchange-traded derivatives that compel a trader to buy an asset at a specified future date. This is why they are called futures. The reason they are similar to contracts for difference is that they require traders to take a position on future prices on the basis of today’s price. It assumes that if the prices in the future raise, the futures price will rise accordingly and that the instrument will be sold upon expiry of the contract for the holder to reap the benefits.
The rigid nature of futures makes these derivatives a bit complex. Some of the aspects that must be considered include the expiry dates and set quantities not to mention the strict rules that apply compared to the CFDs. It is also easy to track and monitor the futures market compared to the CFDs broker of their closed nature of the CFDs. What’s more, the CFD brokers make their price estimates based on the prices set on the futures market. This means that the open nature of futures is the best when it comes to trading derivatives.
The core difference between the two lies in the fact that they are technically different. While prices of futures are market-driven, CFD prices are broker-established. Simply put, futures are structured and less flexible form of form of financial instrument, with leverage benefits more similar to those of CFDs.
Pros of Futures vs CFDs
Futures are thought to be more transparent in terms of prices since they are traded on an open and public exchange markets and traded my different investors and institutions. For this reason, they are commonly traded in a more liquid and large market. What this means is that their prices are a fair reflection of the futures market price. Because CFDs are traded on prices that suit the broker’s needs, the prices are not as open.
The other advantage is the cost-effective nature of futures. They are cost-effective because of their commission structure, especially for traders interested in engaging in substantial volumes of trade. They offer a significant saving particularly on the transaction costs that accompany the trading process.
Downsides of Futures vs CFDs
CFDs are more liquid than futures. The fact that a broker acts as the market where a position cannot be taken, CFDs are considered to be generally liquid derivatives. What this means is that you get orders filled as per your requirements, locking in your benefits you expected at the time of executing the decision. In addition, the value of the futures contract tends to be eroded as we move closer to the expiry date.
The other downside is that futures contracts are expensive for small and medium-sized traders because of the specified amounts of the contracts involved. This means you need a substantial amount of capital upfront in order to buy an interest in the market. On the contrary, CFDs are much more flexible because they give traders an opportunity to take a position on the fly.
In Summary
This overview of CFDs vs Futures gives a basic insight into the main differences between the two financial Instruments. Both have their pros and cons as discussed above and their leverage can make them high risk/high reward. Both require you to take a position on where you believe the price movement is going, and as such it’s important you have a strategy for trading.
