CFDs vs Futures: Key Differences Explained

In the present highly competitive financial markets, traders are always trying to find ways of maximizing returns whilst trying to handle risk. Some of the most popular tools, which are frequently found for comparison, are Futures and Contracts for Difference (CFDs). They are both similar in that traders can speculate on the price fluctuations of assets without necessarily direct ownership of those assets, but they differ greatly in terms of structure, cost, and trading method.

The distinction between CFD and Futures must be understood by all individuals who seek to make informed decisions in leveraged markets. This blog will dissect what CFDs are, what futures trading is, their main differences, trading policies, risks, and how they are incorporated in the management of a modern portfolio.

What Are CFDs?

Contracts for difference (CFDs) are derivative products that give traders the opportunity to speculate on price movements in numerous markets. A CFD is a contract between a broker and trader, which states that those two parties agree to pay each other the difference in value on an asset from the time the trader opens a CFD on that asset until the time they close the CFD. 

• Ownership: Traders do not own the underlying asset when they trade CFDs. Instead, they are trading on whether the market price of the asset rises or falls.
• Market: CFDs are available across many asset classes such as stocks, indices, commodities, and forex.
• Leverage: CFDs are generally traded on margin, which allows the trader to control a large position with a small investment.

For example, if a trader thinks a stock will go up in price, they can buy a CFD on that stock. If the stock increases in value, the trader will account for the difference as profit, whereas if the stock declines in value, the trader will account for the difference as a loss.

What Are Futures Trading?

A futures contract is an agreement that has been standardized to either purchase or sell an asset at a specified price on a particular date in the future. They are commonly applied to commodities, currencies, and indices as well as cryptocurrencies.

• Standardization: Futures are exchanged in regulated markets, and their quantity and time of expiry are predetermined.
• Hedging & Speculation: Futures can be utilized by institutional traders and corporations to hedge price volatility risk, and by traders to speculate.
• Obligation: Futures contracts require both buyers and sellers to complete their deal on the expiry date unless the position is re-closed before the expiry date.

Futures contracts are, in short, a good way to hedge long-term exposure to assets such as oil, gold, or indices because they lock in prices.

Key Differences Between CFDs and Futures

While they allow an investor to take a buy or sell position on the price of an asset, a few essential details set one apart from the other. Let us unbundle these so as to see who might be best suited for what trader.

Contract Structure and Standardization

Futures are more standardized: sizes are fixed, expiration dates are fixed, and terms are fixed. Trades have to be through exchanges such as CME or ICE. Such uniformity ensures ease of trading and great liquidity, but restricts customization. CFDs are OTC products provided by brokers, thus allowing variance with position sizes and no set expiration; in theory, one may keep them forever, although there may be a cost to hold overnight.

Expiration and Rollover

One of the prime differences between CFD and futures is expiration. Futures contracts expire on set dates, carried out by traders with new contracts or settling, hence costs. CFDs do not expire; they are there until one closes them, thus better for holding a longer period without worrying about rolling.

Leverage and Margin

Both offer leverage, but it is the functioning of leverage that makes them different. In the case of futures, leverage is incorporated into the margins that the exchanges prescribe, and these margins are usually lower in the case of intraday trades, to be maintained with punctuality.

For CFDs, the leverage is decided by the brokers and can hence be much higher, sometimes as much as 30:1 or in some cases more, depending on the asset and the regulations. These levels of leverage make CFDs attractive to the smaller traders but also very risky owing to the potential for fast losses.

Market Access and Costs

To trade futures, one has to do so on an exchange, paying commission, exchange fees, and sometimes data fees. CFDs are broker-based and usually have costs embodied chiefly within the spreads (difference between buying and selling price) and the withdrawal of financing charges for positions held overnight. CFDs let retail traders access a more prominent portion of the global markets than futures, which might require certain accounts to access certain asset classes.

Settlement and Ownership

There is a difference in the settlement of these, although neither constitutes ownership of the asset. In the case of futures, a physical delivery can happen if one does not close out in time, but mainly, the cash settlement is the standard in the case of financial ones. CFDs give a pure cash settlement is even simpler, as CFDs will just settle on money based on the price differences.

Regulation and Counterparty Risk

The advantage of futures is that they are regulated by an exchange, which lowers the default risk by clearinghouses. Since CFD is an OTC, it is dependent on the weakness of the broker, but reputable ones are subject to control by regulatory authorities such as the FCA or ASIC. Such a regulatory variation can affect the confidence of traders.

These differences indicate why others find the formality of futures in hedging more appropriate, and others prefer the flexibility of CFDs in speculation trading.

CFDs vs Futures Trading Strategies

Knowing the difference between CFDs and Futures trading strategies is essential in making the correct choice based on one's financial goals and risk tolerance.

Strategies for CFD Trading

• Short-Term Speculation: CFDs lend themselves to being held for a very short time for day trading and scalping purposes.
• Index Trading: CFDs are the most popular instruments for speculating on some global indices like S&P 500, DAX, or FTSE.
• Leverage Trading: With CFDs, traders can enhance their gains on smaller price movements, but the risks must be properly managed.
• Hedging portfolios: Investors may use CFDs to hedge their holdings in shares or commodities.

Strategies for Futures Trading

• Hedging Commodities: Futures are used by producers and consumers of oil, wheat, or gold to fix prices.
• Speculating on Indices: Index Futures contracts enable traders to capitalize on long-term market trends.
• Spread Trading: Calendar spreads are commonly used by futures traders as they buy and sell contracts which have varying expiration dates.
• Arbitrage Opportunities: Some advanced traders take advantage of pricing discrepancies between spot and futures markets.

Risks in CFD Trading and Futures

Each financial instrument is associated with risks, and the only way to come up with effective CFD trading strategies is to become familiar with them.

Risks in CFD Trading

• Excessive Exposure to Leverage: Compounded losses on leverage.
• OFCs: It is costly to hold overnight.
• Counterparty Risk: CFDs are broker-based, and thus, the trust in the broker is of the essence.

Risks in Futures Trading

• High Capital Requirement: Futures contracts often have big margins.
• Expiration Risk: The traders are forced to monitor the expiration dates to prevent undesirable settlements.
• Market Risk: Unpredictable price movements may lead to huge losses.

CFDs vs Futures: Which One Should You Choose?

• The decision of whether to use CFDs or Futures should be made based on your trading style, objectives, and risk appetite:
• CFDs may be the option of choice in case you like flexibility, low capital investments, and trading in the short term.
• Futures are a better choice when you need standardized contracts, a regulated exchange, and long-term hedging.
• They can both be used in a diversified portfolio, particularly when combined with good CFD trading plans and risk management discipline.

Final Thoughts

Both CFDs and Futures offer opportunities on a global scale and provide flexibility, leverage, and access to markets. However, the differences between CFD and Futures are the way they are structured, traded, and used for a financial strategy. While CFDs can be an easier trading option for beginners, experienced traders and institutions tend to use Futures for hedging purposes and large speculation.  Inveslo believes that informed trading decisions will produce long-term wealth.  Contact our experts now to find out what the best trading method is to achieve your financial goals.

FAQs

1. What is the main difference between CFD and futures?

The fundamental difference is structure: CFDs are non-expiry, broker-based contracts that are flexible, whereas futures are standardized and traded at an exchange with a fixed expiry date.

2. Are CFDs riskier than futures?

It will depend; CFDs can be more leveraged, and, therefore, risks become greater, but futures also have margin calls that can lead to an increase in risks-they are both to be handled with care.

3. Can beginners trade futures?

Yes, through education and by beginning with mini contracts, although future contracts require knowledge of exchanges and expirations, and thus are a little more difficult to begin with than mini contracts.

4. How does leverage work in CFD trading?

Leverage provides you with a chance to trade bigger positions by using a smaller deposit (margin), such as 10:1, that is, when you deposit one dollar, your position controls 10, and so every gain or loss is multiplied accordingly.

5. What assets can I trade with CFDs?

CFDs include stocks, forex, commodities, indices, etc, and offer extensive market coverage on one broker platform.

6. Do futures always involve physical delivery?

Most of them are cash-settled, particularly financial; physical delivery is not common among speculators who roll out of positions before maturity.