CFDs emerged in early 1990s as a reaction to desire of institutional investors and hedge funds to short sell shares, while avoiding inconvenient and often expensive borrowing procedure. Initially, market makers were the only party allowed to short sell shares on London Stock Exchange. It was exactly market makers, who offered their institutional clients to take advantage of Contracts for difference as over-the counter-instruments allowing, among other things, to avoid paying stamp duty. Indeed, as you buy a CFD, physical purchase of underlying shares doesn’t occur, therefore, there is no subject of taxation. Being able to short sell a stock index, such clients could hedge their security portfolio fast, while paying just a small part of an underlying asset’s price (margin). In the following years the advantage combination of CFDs stimulated explosive growth of popularity and trading volume.
Retail investors interest
In the late 1990s major institutional player Gerard and National Intercommodities (GNI) came into retail market and introduced CFDs for shares listed on the London Stock Exchange (LSE) via its innovative trading platform GNI Touch operated from a personal computer with the internet-connection. Origination of this service provided retail clients with direct access to LSE, and taking into account the potential of high leverage, it’s easy to imagine the popularity of new instruments among retail traders. Soon several European and British financial houses followed the same path, because advantages of CFD trading became evident.
Attractive features of CFDs
The reason why Contracts for difference became popular among retails traders, semi-professional and professional investors is the following:
- They might provide certain tax advantages. For instance, in Great Britain transactions with CFDs are exempt from tax (stamp duty), which is 0.5% per transaction.
- High leverage is available for trading a vast variety of instruments.
- CFDs allow short selling of assets investors are interested in, without necessity to borrow the assets from a broker and pay for the loan.
- Many strict rules of stock trading do not concern CFDs.
These four significant properties made CFDs as popular as they are.
For instance, absence of transaction taxes and high leverage are ideal combination for speculative trading, while lack of position volume limitations provided hedge funds with the possibility to accumulate or short sell large volumes of securities.
Prospects of Contracts for difference
Future of CFD trading looks promising. London Stock Exchange (LSE) and Australian Stock Exchange (ASX) have already introduced standard contracts as listed instruments. Thus, retail traders are not obliged to open accounts with a liquidity provider anymore, instead, they can trade CFDs directly in the market via an ordinary broker.
Investors may freely trade CFDs in such countries as Great Britain, Germany, Switzerland, Italy, Singapore, South Africa, Australia, New Zealand. In Great Britain legislation even allows to include CFD into self-invested pension plan (SIPP). At the same time, trading these instruments is forbidden in USA.
AForex invites you to become a part of the international market of Contracts for difference!