A contract for difference, or equity CFD, is a contract between two parties that allows them to speculate on the changes in a stock without either actually owning the stock. Two parties create a contract that states that the buyer will pay to the seller the total difference between the value of the stock at the time the contract begins and its value at the time the contract ends. If the value goes down, the seller must pay the buyer the difference. Equity CFDs are designed to be used mostly by frequent traders in a given market rather than by long-term investors. An equity CFD is not a legal contract in all countries.
An equity CFD can be created either between two individual traders or between an individual and a contract for difference provider. If it is offered by a provider, there may be a brokerage fee associated with the transaction. The terms of the contract are not standardized, though they do tend to share certain characteristics. CFDs are always traded on margin, meaning one party has to offer collateral to the other to cover the credit risk of the transaction. The life of the contract is usually no more than a day or two, and contracts generally accrue a daily finance charge.
The equity CFD is a trading option available in many countries, including the United Kingdom, Australia, and Canada, but it is not available to traders in the United States. The U.S. Securities and Exchange Commission has restricted the direct trade of certain commodities, stocks, and bonds. Trading must be done on an exchanged designed for that purpose rather than directly between two parties. This type of direct trading is known as over-the-counter trade and is heavily regulated in the United States.
The financial world generally gives credit for the creation of the equity CFD to Brian Keelan and Jon Wood, who both worked for the global financial services firm UBS. Whether created by these men or not, equity CFDs first developed in London in the early 1990s. One of the major advantages of equity CFDs was that they were not subject to the 0.5 percent stamp tax levied against stock exchange trades in London. Originally, equity CFDs were used by a type of investment fund known as a hedge fund to protect its investments against losses. The use of equity CFDs quickly spread throughout the financial sector.