In this article, we will be tracing the history and evolution of CFD (contract for difference) trading. CFD trading has come a long way since its inception and has seen many changes over the years. In order to understand the future of CFD trading, we must first have an introduction to CFD trading’s past.
CFD trading goes right back to the 1500s where it began in Antwerp in Belgium and moved onwards to Hamburg, Amsterdam, Rouen and then over to the UK. We can see contracts for difference being argued about in 1850s English case law, “when these contracts were entered into it was the intention of both parties that the stock should not be delivered, and that the transactions should end in the payment or receipt of differences“.
New style CFD trading had a resurgence since the early 1990s and because they are a way for traders to trade stocks and other assets without having to purchase the underlying asset, certain tax advantages can be realised.
Online CFD brokers came into prominence in the early 2000s, making trading more straightforward and available to individual traders globally. The appeal of CFD trading has continued to grow, especially among the retail trading community, and it has consequently evolved into one of the most widely traded financial instruments in the World.
Introduction to CFD Trading
Introducing CFD Trading
A “contract for difference” (CFD) is a contract made between two parties concerning the movement in value of an underlying asset. There is no ownership nor right to the underlying, only the agreement to settle the difference in value at closure.
CFD trading refers to the buying and selling these Contract for Differences (CFDs). Not only do these financial instruments allow traders to speculate on the price movements of an asset without owning it but they also come with tax and leverage advantages a result. For example trading a CFD based on a company’s stock price does not attract stamp duty in the UK, whereas trading the actual shares would.
A contract for difference is traded ‘over-the-counter’ (OTC), which means that they are generally not listed on a centralised regulated exchange, whereas stocks or standardised futures contracts are. There have been some exceptions to this where some CFDs were placed on a regulated exchange in Australia for a while or where crypto futures traded on an unregulated exchange like FTX but neither were success stories.
Origins of CFD Trading
As noted in our initial overview above, CFD trading goes way back to the 1500s where it began in Antwerp in Belgium. However, it wasn’t until the 2000s, when CFDs were introduced to online retail traders and truly gained momentum with the general public.
CFD Trading in the Present
In the present day, CFD trading has undergone significant changes. The marked development of online trading platforms since the dot com boom has made CFD trading more accessible to the masses while demand for trading new assets like cryptocurrencies has increased the instruments’ utility. Moreover, regulatory bodies have implemented new rules to increase transparency and protect investors, such as the ESMA’s (European Securities and Markets Authority) restrictions on their leverage.
Future of CFD Trading
The future of CFD trading looks promising, with new trends emerging that could revolutionize the industry. For instance, the use of automation and AI in trading could lead to more efficient and profitable trading strategies. Additionally, the rise of decentralized finance (DeFi) could create new opportunities for CFD traders by allowing them to trade tokens peer-to-peer without intermediaries.
💡 Key Takeaway: In this aerial overview introduction to CFD trading we note it has come a long way since its inception in the 1990s. While the past has been marked by innovation and regulatory changes, the future of CFD trading looks bright with the emergence of new trends and technologies.
What is CFD Trading?
CFD, standing for “Contract for Difference,” is a financial derivative product. It provides investors with the opportunity to speculate on the price movements of underlying assets without actual ownership. Its flexibility and margin-friendly features have made it a favored trading form among retail traders worldwide. However, there are some notable country exceptions where it doesn’t exist for regulatory reasons such the United States and Hong Kong which we examine further in a separate article.
CFDs are quoted to replicate the underlying asset or security which is it associated with, so traders and investors aren’t dealing with the original just a synthetic equivalent, a bit like buying a synthetic lottery ticket from Lottoland. Put simply, if a trader believes that the price of an asset will rise, they can buy a CFD to profit from that price increase. On the other hand, if they believe that the price of the asset will fall, they can sell a CFD to profit from that price decrease.
Unlike conventional trading methods where traders have to own the underlying asset to buy or sell, CFD trading provides traders with the ability to take a leveraged position on that asset by putting up a percentage of the total trade value as margin. The lower margin requirement in CFD trading allows retail traders to potentially earn high returns on their investments with a relatively small amount of capital which is attractive to retail sized accounts and potentially leaves extra money for other trades.
Major futures exchanges are recently fighting back for a share of the action with the introduction of micro and nano futures small enough to attract retail traders, particularly in the United States where CFDs don’t exist. Exchanges like CME are going even further, somewhat amazingly introducing binary options, which they rebranded as ‘event contracts’. Interestingly much of Europe and the rest of the world banned binary options for being exploitative gambling products.
However, contract for difference trading has been catering to retail demand for over 20 years around much of the rest of the World and maintains a strong foothold beyond the US.
💡 Key Takeaways: CFD trading is a type of derivative trading that enables investors to speculate on the price movements of an underlying asset without owning it. This flexible and margin-friendly trading method provides retail traders with the opportunity to earn potentially high returns on their investments with a relatively small amount of capital compared to trading something like full-size futures contracts.
– While Americans have so far missed out on any introduction to CFD trading, their regulated exchanges are now competing in the space, even introducing gamified gambling products for small retail accounts which other countries already banned for being exploitative, such as binary options.
The Origins and Expansion of CFD Trading
Modern CFD trading can be traced back to the late 80s and early 1990s. According to a report by the UK Financial Conduct Authority (FCA), CFDs were redeveloped in the early 1990s by a group of professionals working for a London-based investment bank. It was Brian Keelan and Jon Wood from UBS Warburg who are specifically recognised for the modern interpretation of a very old instrument. The report states that “CFDs were first developed in the early 1990s to allow institutional investors to hedge their positions in equities without having to buy or sell the underlying shares.” Note it says ‘developed‘ not ‘invented‘, many articles on CFDs talk about the invention of CFDs being in the 80s but they were invented about 500 years earlier in reality! CFD trading was actually clamped down on in 1541:
“There is also evidence that contracts for difference, where a losing party could compensate the winning party for the difference between the delivery price and the spot price at the time of settlement, were largely used. Because they gave traders too much leverage to speculate, these contracts were banned in 1541. Despite the ban in Antwerp, contracts for differences continued to be used in Hamburg, Rouen and Amsterdam as regulation of derivatives was not uniform throughout these market places.“
Christian Pauletto “The History of Derivatives -A Few Milestones” see also Dr Ernst Jeurg Weber “A Short History of Derivative Security Markets“
Modern CFDs trading gained popularity in the UK due to the tax benefits they offer, and soon after, spread to other countries in Europe and places like Australia and New Zealand. In the early days of CFD trading, there were only a small number of providers such as GNI and a limited number of markets to trade on. However, over time, CFD trading has evolved with early providers such as CMC Markets, City Index and IG still very much evident, alongside a multitude of newer CFD providers and an abundance of markets to choose from.
Today, CFD trading has become an essential part of the financial landscape, enabling traders to speculate on a wide range of asset classes, including stocks, indices, and currency pairs, among others. According to a report by the European Securities and Markets Authority (ESMA), in 2020, retail traders executed 2.37 billion trades in CFDs alone, with a total value of €1.77 trillion.
Moreover, technological advancements have had a substantial impact on the evolution of CFD trading, allowing traders to access the markets from anywhere, at any time, using their computers or mobile devices. This convenience and accessibility have made CFD trading ever more popular among retail traders over the past decade.
💡 Key Takeaway: CFD trading was developed in the early 1990s to allow institutional investors to hedge their positions in equities without having to buy or sell the underlying shares. Over time, CFD trading has evolved to become an essential part of the financial landscape, allowing traders to speculate on a wide range of asset classes. Technological advancements have also made CFD trading more accessible than ever before.
Modern History of CFD Trading
Modern CFDs introduced in the early 2000s available to the general public allowed for smaller contract sizes and lower transaction costs.
CFDs gained popularity during the dotcom boom, with retail traders mainly using them for the purpose of speculating on the direction of technology stocks. As the financial industry evolved, so too did CFD trading, with traders diversifying into other markets such as commodities, currencies and indices.
In 2018 the UK’s Financial Conduct Authority (FCA) announced a clampdown on the trading of CFDs due to their risks (477 years after the Dutch initially banned them). The FCA found that 82% of traders lost money with their CFD provider and that CFDs “pose a significant risk to retail consumers”. If you log onto UK CFD providers’ websites with a UK connection you will see they have to clearly publish what percentage of their traders are losing money, although this information is removed if look at the sites from abroad. However, despite regulatory changes, CFD trading continues to gain popularity globally and according to the Financial Times, the global CFD market is expected to grow by 15.2% between 2019 and 2025.
💡 Key Takeaway: CFD trading evolved from financial swaps and has grown in popularity over the years, leading to regulatory changes. Despite these changes, the CFD market is still expected to grow in the coming years.
CFD Trading in the Present
Modern CFD trading has evolved into a highly sophisticated and competitive industry. Its landscape is continually changing and adapting, shaped by an emphasis on technology, innovation, and regulation. One major change in CFD trading in recent years has been the continued development of online trading platforms. These platforms have made CFD trading more accessible to retail investors and have provided an unprecedented level of convenience, particularly with smart phone apps allowing traders to execute trades on-the-go, alongside additional functionality choices such as guaranteed stop loss orders.
Furthermore, there has been a greater focus on transparency and investor protection, with new rules and regulations being introduced by regulators worldwide. For instance, in Europe, the Markets in Financial Instruments Directive II (MiFID II) has placed emphasis on greater transparency in pricing, and the prohibition on accepting inducements in exchange for business. This has led to better outcomes for investors and a generally higher level of trust in the industry. In summary, CFD trading in the present has become a dynamic and rapidly evolving industry that is highly focused on technology, innovation and investor protection.
💡 Key Takeaway: CFD trading has evolved significantly in recent years, with a greater emphasis on mobile trading platforms, transparency, and investor protection.
Changes in CFD Trading
Recent years have seen significant changes in CFD trading. Among the most impactful of these is the ramped-up regulation of CFD trading by financial authorities. As a result of this increased regulation, CFD brokers are required to provide more transparent pricing and risk management tools to their clients. As mentioned, several CFD brokers have implemented negative balance protection policies to ensure that clients cannot lose more than their account balance.
According to a report by Finance Magnates, 47% of all trades conducted through CFD brokers back in 2019 were already done via mobile devices and this has continued to grow in recent years. This highlights the importance of mobile trading platforms for CFD brokers and the need for them to adapt to the changing client demands. It is in the CFD provider’s interest to do so, as the more trades their clients do, the more money they take in commissions and spreads.
Finally, the increasing popularity of social trading has also impacted CFD trading. As more traders seek to learn from successful traders and mimic their trades, CFD brokers have started to integrate social trading platforms into their offerings – eToro has been driving this particularly hard with its advertising recently. This trend is expected to continue in the future as more traders seek to benefit from the wisdom of the crowd.
💡 Key Takeaway: Increased regulation has led to more transparency and protection for traders in CFD trading. Mobile trading platforms and social trading are changing the landscape of CFD trading and brokers must adapt to meet the changing demands of traders and it’s very much in their interest to do so, particularly in such a competitive market place.
The Future of CFD Trading
As we look to the future of CFD trading, alongside device availability and social trading, we can see other trends emerging that are likely to shape the industry in the years to come. One key trend is the increasing use of automation and artificial intelligence in trading algorithms. This is already evident in the rise of robo-advisors and other automated trading systems, which are designed to execute trades at lightning speed and with remarkable accuracy. As one expert in the field puts it, “I think automation and AI will play a massive role in the future of CFD trading- it’s already happening and will only continue to accelerate.”
Finally, we can expect to see continued growth and innovation in the CFD trading market as a whole, as more traders worldwide begin to recognize the many benefits of this trading instrument. As one analyst put it, “CFD trading offers so many advantages over traditional trading methods- lower costs, greater flexibility, and the ability to trade a wide variety of assets. As more traders realize this, the market will only continue to grow and evolve.”
💡 Key Takeaway: The future of CFD trading will likely be characterized by increasing automation and AI, a shift towards mobile trading platforms, and continued growth and innovation in the market as a whole.
Summary of Trends in CFD Trading:
Recent years have seen CFD Trading transformed by technological advancements, regulatory standards, and market volatility. Below is a summary of noticeable trends in CFD trading in the present:
1. Alternative asset classes: Investors are exploring alternative asset classes such as cryptocurrencies, commodities, and ETFs, which offer greater flexibility and higher potential profits.
2. Social trading: With the emergence of social media platforms, traders can now collaborate and follow other investors, allowing them to gain insights and improve their trading strategies.
3. Mobile trading: The growth of mobile trading platforms has made it possible for traders to access markets and place trades on-the-go, increasing market participation and trading volumes.
4. Automation: Automation and algorithmic trading are becoming more popular in CFD trading, allowing traders to execute complex trades automatically and generate profits on a 24/7 basis.
5. Increased regulation: Regulatory authorities are tightening their grip on CFD trading, introducing measures to protect retail investors and reduce market risk.
💡 Key Takeaway: With the emergence of alternative assets, social trading, mobile platforms, automation, and increased regulation, CFD Trading is undergoing significant changes that are shaping the future of the industry. It is important for traders to stay up-to-date with these trends to stay competitive and informed.
Predicting the Future of CFD Trading
As we have seen, CFD trading has grown tremendously over the past few years, and it is expected to continue expanding in the future but is facing increased competition from exchanges that previously dismissed retail traders, such as CME. The rise of big data and artificial intelligence is expected to have a significant impact on CFD trading. Big data can help traders to make better decisions by providing real-time data and insight into market trends. The use of artificial intelligence in trading algorithms can also help to reduce human error and improve the efficiency of trades.
Apart from technological advancements, regulatory changes are also expected to have a significant impact on the future of CFD trading as we have already seen in Europe. For example the Dubai Financial Services Authority (DFSA) recently decreased the amount of leverage CFD providers could offer customers.
Finally, the increasing interest in digital assets and cryptocurrencies is also expected to impact the future of CFD trading. Only relatively recently have some brokers have started to offer cryptocurrency CFDs and it is predicted that this trend will continue.
💡 Key Takeaway: The future of CFD trading is expected to be shaped by technological advancements such as big data and mobile devices, regulatory changes, and the increasing interest in cryptocurrencies and digital assets. It is important for traders to stay up to date with these trends to make informed trading decisions.
Conclusion
In this blog post, we explored the history and evolution of CFD trading, and looked into the future of CFD trading. CFD trading is a relatively new form of investment compared to stocks, futures and options trading and has seen rapid growth in recent years. CFD trading is a type of derivative trading that allows investors to trade stocks, commodities, currencies, indices, and other assets without actually owning the underlying asset. CFD trading has been around for over two decades, but it has only recently seen widespread popularity. This is likely due to the low barrier to entry and the ability to trade anywhere at any time on a global scale. CFD trading can be a volatile investment tool, and it is important to do your research before investing in this type of trading particularly as over 80% of retail clients lose money CFD trading.
Test Your Knowledge
- Question: What does CFD stand for in financial trading? Answer: CFD stands for “Contract for Difference”.
- Question: Where and when did CFD trading originate? Answer: CFD trading originated in Antwerp in the 1500s.
- Question: How did CFD trading gain popularity? Answer: CFD trading gained popularity in the 2000s when it was introduced to retail traders.
- Question: Why is CFD trading popular among retail traders? Answer: CFD trading is popular due to its flexibility, ability to trade on margin, and the fact it doesn’t require owning the underlying asset. It is very similar to spreadbetting but treated differently for tax.
- Question: What are the key trends shaping the future of CFD trading? Answer: Key trends include increased use of automation and AI, a shift towards mobile trading platforms, and the rise of social trading.
- Question: How has regulation impacted CFD trading in recent years? Answer: Increased regulation has led to more transparency, better risk management tools, and greater protection for traders in CFD trading.
Leave a Reply