A Short History of CFDs. Photo: Hieu Vu Minh

Trader Homework: A Short History of CFDs

Contracts for Difference, or CFDs, were originally developed in the early 90’s, by a trading firm based in London called Smith New Court. The company was subsequently purchased by Merrill Lynch in a deal worth over £500 million.

OTC (over the counter) or equity swap markets made up CFDs' initial identity and were used by institutions to hedge their equity exposure by utilising risk, reducing and market neutral trading strategies. Originally, CFDs were a cost effective way for Smith New Court’s hedge fund clients to sell short on the London Stock Exchange, with the benefit of leverage and to benefit from stamp duty exemptions.

During that period of time, market makers in listed stocks were the only traders permitted to go short of securities and so these market makers used CFDs as over-the-counter products to institutional traders.

In the late 90’s CFDs were introduced to private clients and the retail market via an online trading arm called GNI Touch. It offered clients CFD products and a trading system which allowed clients to trade online directly into the London stock exchange. Clients identified that the main advantage of trading CFDs was the ability to trade on leverage, as traders and investors were able to take leveraged long bought positions and short sold positions without having to take delivery of underlying shares.

CFDs are in addition a tax free product and the trading process is quite clean. They can currently be traded in many countries including Australia, UK, Germany, Switzerland, Italy, Singapore, Thailand, South Africa, Canada, New Zealand, Hong Kong, Sweden, Norway, Belgium, Denmark, Netherlands, France, Spain, and to non-residents in the US.

In the early days in the United Kingdom for example, CFDs were labelled swap contracts and only became popular with investors in around 2001. CFDs began gaining popularity due to the fact that the transactions didn’t attract any stamp duty.

But what does the market look like today and what does the future hold for CFD trading?

To understand CFD is helpful when learning trading. Trends indicate that Forex providers are increasingly targeting the European markets to expand their businesses, due to recent unfavourable regulatory framework adopted by both the US and Japan.

So to maintain a competitive offering in Europe, they started offering CFDs to complement their Forex offering. In line with this, local spread betting brokers responded by increasingly injecting more advertising money to promoting CFDs, driving an increase in CFD trading.

Moving into 2021 and beyond, there are a number of factors which will dictate the path CFD trading takes. Even though analysis does not predict any dramatic twists, unexpected events can always occur. The global health crisis that is occurring at the time of writing could well be over swiftly due to a vaccine being rolled out across the continents, however a mutated variant or third wave would be an unexpected scenario in which traders should be mindful.

A change in leadership in the US, with an incoming president changing various policies and direction for the country, will also lead to changes in markets and a degree of uncertainty as we move deeper into 2021.

However, CFD trading is predicted to go from strength to strength in the short term future.

By Predrag Milicevic