If you’re looking to get into online trading account, then you might have come across the term “contracts for differences.” Also called CFDs, many brokers and platforms offer these assets throughout the web, often making promises of major returns. However, these opportunities may not be all they seem. CFDs are often poor choices for investment – and are sometimes even illegal.
Table of Contents
What Are Contracts for Differences?
Contracts for differences are derivative assets that take the form of a contract between a buyer and a seller. Basically, the buyer agrees to pay the seller the difference between a specific asset’s current and future values on a set date.
It can be thought of as a kind of bet on which way prices are going to go. At no point is either party actually in possession of the asset in question. CFDs are often based on stocks, foreign exchange, commodities, and even cryptocurrencies. If you purchase CFDs on a specific asset, you never actually own it, only the contract agreement.
This type of investing bypasses the need for an exchange to manage actual transfers of assets. Instead, CFDs are essentially made up out of thin air by brokers. The entire process is based on agreements, with no tangible assets changing hands.
Are Contracts for Differences Legal?
Like many other types of assets, the legality of CFDs varies from country to country. Some have outright bans, while others place specific restrictions in order to protect retail investors. The UK, the European Union, Australia, New Zealand, Canada, and many other countries have a variety of regulations in place that allow for CFDs to be traded with restrictions and consumer protections.
CFDs are often traded on margin, meaning that the trader has some certain amount of leverage. Essentially, they are investing more than they put down, opening themselves up to greater risk or reward. Many restrictions limit leverage to prevent retail traders from getting in over their heads. In the UK and the EU, the maximum is 30:1, with some specific CFDs having stricter limits.
In the United States, CFDs are banned outright by the US Securities and Exchange Commission (SEC). They are banned due to their widespread use outside of regulated exchanges and the inherent risk that leverage poses to retail investors. They are also prohibited in Brazil. The majority of remaining countries have no specific regulations affirming or restricting CFDs, so they are treated like any other investment asset.
These types of bans by regulating entities were prompted by complaints made by victims who made a decision to join any number of get-rich-quick schemes such as “Immediate Edge” which was exposed here.
Why Do So Many Online Brokers Push CFDs?
The internet is rife with online CFD brokers promising major returns. However, they rarely deliver. These brokers choose CFDs specifically because no tangible assets or regulated exchanges are involved. This makes it much easier to carry out a variety of scams ranging from taking advantage of exorbitant fees to outright stealing investor money.
Many online CFD brokers flout regulations and restrictions. They are often based in countries with rarely enforced investment laws. They offer their CFDs online to traders from essentially any country, ignoring any rules about maximum leverage they might have. You’ll often find brokers offering leverage of 100:1 or even 500:1, much higher than the allowed limits.
Should I Invest in CFDs?
Even legitimate CFD trading carries significant risks. This makes them a poor choice for everyday investors. While professionals might be able to use leverage and other tools to generate profits, the risk is incredibly high. Combined with the frequency of outright CFD scams around the web, this likely means that CFDs aren’t right for you. Instead of relying on this derivative asset, direct investing in stocks, commodities, and other assets through a registered broker may be the better choice.