CFD Trading vs. Futures Trading: 5 Basic Differences

In the last few years, CFDs and futures have become popular ways of trading a variety of markets and different instrument classes, like shares and forex pairs. Namely, these are derivative products that have their price linked to a real financial instrument. Since they are derivatives, they are relatively easy to trade and can be traded with leverage, making them attractive to traders.

Still, many use CFDs and futures interchangeably, not recognizing that there's an innate difference between them. So, what are the differences between CFDs and futures? Keep reading to find out.

CFD Trading Defined

CFD is an abbreviation for contract for difference, a type of derivative trading that enables traders to speculate on the price movement of underlying instruments without actually owning them. CFDs are traded on margin, which means that traders can leverage their positions to enter larger trades than they would otherwise be able to afford. Although CFDs are beginner friendly, one of their biggest downsides is overnight fees (also known as swap fees), which are charged for every night the position remains open. Although these fees are small (usually less than 0.5%), the amount can quickly add up.

Example of CFD Trading

With a CFD position, a trader can trade the price of 100 shares of Microsoft (MSFT) while having capital in the account to trade for just 1 share price. Then, if Microsoft's stock price goes up by $1, the account balance for that trade will increase by $100. If it drops by $1, the account balance will decrease by $100.

Since CFDs have no expiration date, the trader can close the position whenever they see fit but will have to pay an overnight fee for each day the position remains open.

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Futures Trading Defined

Futures are a type of contract that obliges the holder to buy or sell an instrument at a predetermined price at a specified date in the future. As a derivative product, futures are slightly more complex than CFDs, as they require knowing more details about the instrument to fill an order.

Example of Futures Trading

Say, for example, the price of Microsoft stock is trading at $250 per share, and a trader makes a futures contract with an expiration date in December with 1:50 leverage. If the Microsoft stock trades at $255 per share in December, the trader will end up with a 50 X $5 = $250 profit (50 due to the leverage and $5 in the price change).

On the other hand, if the price of the stock goes down to $245 when it expires, the trader will incur a $250 loss.

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5 Main Differences Between CFDs and Futures

Instrument Classes

The first major difference between CFDs and futures is the range of instrument classes that they can be used to trade. Futures contracts are mostly used for trading commodities such as oil, gold, or natural gas.

On the other hand, CFDs can be used to trade a much wider range of markets, including forex pairs, the price of stocks, and indices.

Charges

When trading futures, a trader has to pay a fee charged by the brokerage for each trade. The size of the commission depends on the brokerage but is usually a few cents per traded contract.

When it comes to CFDs, the charges are built into the spread. The spread is the difference between the buy and sell price of an instrument and goes to the brokerage as a commission. Futures contracts also have spread, but they're significantly lower than those of CFDs.

Expiry Dates

As we already mentioned, futures have an expiration date, meaning that a position has to be closed before the contract expires (i.e. when the instrument will be exchanged). Still, in many cases, futures contracts can be extended throughout another contract period, so the position doesn't necessarily disappear upon expiration.

In contrast, CFDs don't have an expiration date, so a position can be kept open for as long as the trader wants.

Holding Periods

Futures contracts are held until they expire, while CFDs can be closed at any time.

However, CFD positions have an overnight fee, which is charged once a day for every day you hold the position. Because of this, the majority of experienced stock traders won't recommend holding a CFD position for too long, as it can quickly deplete your profits. So, as a beginner, you shouldn't hold a CFD position for more than a week.

Ownership of Instruments

Finally, it's important to mention that CFD traders don't actually own the underlying instruments. They only speculate on the price movement.

On the other hand, futures traders own the underlying instrument in case of a physical settlement. This is important to keep in mind if you're planning on using futures as a hedging tool.

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Which Should You Choose?

CFDs and futures are both derivative products that can be used to speculate on the price movement of underlying instruments. However, there are some key differences between them, such as the range of instrument classes they can be used to trade, the charges involved, and the way they are settled. It's important to understand these differences and learn about the risks of each approach, allowing you to develop a reliable risk-mitigation strategy.

As a beginner, short-term trading with CFDs might be a better choice, as the positions can be closed at any time, giving you a chance to react in case you start losing more than you can tolerate. On the other hand, futures have no overnight fees and might be better in the long term. Nevertheless, both of these approaches have their advantages and disadvantages, and with the right risk management, you'll be able to develop a solid trading strategy.