CFDs History: In the Beginning
CFDs Explained: A contract for difference (or CFD) is a contract between two parties, buyer and seller, stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time. (If the difference is negative, then the buyer pays instead to the seller.) Such a contract is an equity derivative that allows investors to speculate on share price movements, without the need for ownership of the underlying shares
Contracts for differences allow investors to take long or short positions, and unlike futures contracts have no fixed expiry date or contract size. Trades are conducted on a leveraged basis with margins typically ranging from 1% to 30% of the notional value for CFDs on leading equities.
CFDs are currently available in listed and/or over-the-counter markets in the United Kingdom, Germany, Switzerland, Italy, Singapore, South Africa, Australia, Canada, New Zealand and most recently Sweden. Some other securities markets, such as Hong Kong, have plans to issue CFDs in the near future. CFDs are not permitted in the United States, due to restrictions by the U.S. Securities and Exchange Commission on OTC financial instruments.
In the Beginning
Contracts for Difference originated in the 1980s within the institutional environment. The term back then was ‘equity swap’ and was created for large financial institutions and banks to hedge their share positions. These trades were costly and required a high level of administration, making them unattractive to retail traders.
Since 1999, CFD trading has been available to retail investors, first spawning in the UK then flowing across the rest of Europe, and now, the world.
There are a few different takes on ‘why’ the popularity of CFDs has dramatically increased over the past decade, while I am not sure which of the following have the greatest weight in this growth, I know they were all key contributors.
The UK Financial Services Act which came into effect in 1988 was the beginning. This encouraged individuals to take up private ownership of shares and drew a large number of people to the financial markets. Suddenly everyone had the ability to own a piece of the pie. The constantly moving numbers of the companies and indices on the exchange gave birth to a whole new breed of speculative traders and then, full blown gamblers. The complexity of the stock market meant it was not suited to all types of gamblers, thus spread betting firms started to specialize. Some of these firms converted into the CFD brokers we have today and they brought their customer base with them.
Since the first CFD brokers birth in 1999 their popularity has skyrocketed. Initial interest grew in the UK as traders buzzing with excitement of the stock boom looking to avoid stamp duty turned to CFDs. CFDs continued to grow with the introduction of short positions allowing users to make money on the falling markets and/or hedge their existing portfolios for a margin of the cost.
But possibly the largest key contributor to CFDs has been technology, namely the internet. With the introduction of live remote prices and online brokers, CFD trading became possible from home. Due to the short term positions of CFDs and the high margins, speed to market, accurate prices and systems are vital for successful CFD trading. The internet was the platform to deliver these.
Now CFDs are used world wide by all levels of traders and are growing at an exponential rate! While they are still illegal in the US, many US investors are turning to the European and Australian brokers as they still allow trading on US stocks.