Contracts for difference and futures are often a point of confusion for new traders, because in essence they seem to be reasonably similar products. Of course, both are derivatives, and both provide much the same leverage benefits that are common across derivatives generally. However, that’s not to say there are instances where futures might be more suitable than CFDs, and vice versa. Whereas futures are usually traded on exchange and CFDs more commonly traded directly with brokers, the main distinctions lie in the liquidity and financing of both instruments, with CFD orders being more readily filled in practice, and having lower barriers to entry than futures contracts as a rule.

What Are Futures?

Futures are exchange-traded derivatives that bind a trader into buying or selling underlying assets at a specific price at a specific future date – hence ‘futures’. They work in much the same way as contracts for difference, because traders take a position on future prices based on today’s price point. If prices rise in future, the futures price will rise and so the instruments can be resold or executed on the expiry date in order to reap the maximum reward. Futures are complicated somewhat by the rigidity they introduce into the equation – expiry dates, set quantities and stricter rules of enforcement as compared to CFD trading.

The futures markets are however almost entirely transparent, tracking the underlying market more closely than any CFD broker ever will. Furthermore, many CFD brokers use the futures market as the basis for setting their prices, only to further handicap traders against the most likely outcomes. This effectively means that for more price honesty, publicly traded futures are the way to go in preference to CFDs, although order filling is often slightly more sluggish than when trading with a CFD broker directly. As a result, it tends to be something of a balancing act in determining when futures or CFDs may be a better instrument of choice.

Why Buy Futures?

Futures are bought for much the same reasons as CFDs are bought. Futures traders are interested in investing with an eye to future prices, with a view to settling on the difference in price between when the position was entered and exited – either by virtue of a resale of the futures contract, or through exercising the contract on its expiry date. Futures contracts are leveraged because they have a value distinct from that of the underlying assets to which they relate, and they can be traded on margin for an additional risk/reward kick. Essentially, with a few key exceptions, they represent similar instruments used to trade in similar situations, although knowing when to use either is where the real skill lies.

The major distinction lies in the technical differences between the two instruments. Futures are traded on exchanges, which means market-established prices, versus broker established prices with CFDs. This guarantees that there will be more price integrity when trading futures as compared with CFDs, although that comes with the various restrictions of futures contracts over CFDs. In its simplest form, it’s perhaps easiest to think of futures are being a more structured and less flexible version of CFDs, delivering many similar benefits in practice.

Advantages Of Futures vs CFDs

More Price Transparency: Futures are traded on open, public exchanges, and are bought and sold by a range of different investor types and institutions. As a result, they are traded in an essentially large, moderately liquid market, which means prices tend to more closely reflect the value of the futures contract and the underlying asset at hand. In fact, many CFD prices are computed from the underlying futures market price, then adjusted to suit the broker, effectively adding a layer of distortion to pricing that isn’t present when trading futures proper.

More Cost Effective For High Quantity Trades: because of the nature of the commission structure, futures contracts are often more cost effective for traders looking to trade in substantial volumes. Generally designed for more serious scale investors, futures offer a significant saving on the transactional costs associated with trading the markets, and as such represent a more cost-efficient way of doing business to yield often largely similar results.

Disadvantages Of Futures vs CFDs

Less Liquidity Than Broker CFDs: because CFDs are largely traded directly with the broker, it is commonplace for the CFD broker to act as the market maker in situations where positions cannot be directly matched. This has the effect of making Contracts For Difference generally much more liquid than futures, which in themselves are a reasonably liquid derivative. This means orders get filled as per your request and when you request it, ensuring you preserve your profits and get the pay out you anticipated when you executed your settling decision.

Expiration Date: the expiration date attached to futures serves to build in price decay, whereby the value of the futures contract is gradually eroded, all things being equal, the closer we get towards the expiry date. But beyond that, the definite end date eliminates the flexibility of the CFD – one of the CFD’s greatest strengths – by stipulating and compelling the bearer of the futures contract to act on his order on that date. Whereas CFDs can be allowed to run ad infinitum (or until the money runs out), futures have a set-in-stone date for expiration that cannot be altered or modified.

Barriers To Entry: futures contracts are often prohibitively expensive for smaller traders to invest in, because of the rigid size of the contracts involved. While one CFD is usually equal to one share, that definitely isn’t the case with futures, and traders will often be required to fund a hefty amount of capital upfront in order to acquire an interest in the market. For this reason, CFDs are more flexible in that they allow traders to take positions on the fly, whereas futures investment by their sheer scale must be much more definitive and reasoned. And for traders with modest amounts of capital to play with, it really does make sense to keep with CFDs over futures – at least in the short term.