As contracts for difference are seen as a risky investment choice they are seen by many investors as something to be avoided if at all possible.  This is a shame, as they can be very useful for most retail investors.

There are two main roles for a contract for difference as part of a balanced portfolio that encompasses shares, commodities and investment funds.  The first is as a hedge and the second is as a way of playing a movement in the markets.

A hedge means using a contract for difference to bet in the opposite way from your main holdings.  For example if you hold a large number of shares then a contract for difference betting that the share price would go down would be a hedge.

A hedge should be set considerably lower than the current price.  The idea of a hedge is to act as an insurance against a catastrophic loss, not any loss.  Otherwise there will be no chance of making any gains with the portfolio as every upward movement is mirrored by a downward movement.  The transaction costs, however, will mount up.

Another reason to use Contracts for Difference in a balanced portfolio is to chase “outliers”, or events that although unlikely could well pay off.  It has been shown that the market has a massive bias towards standard and predictable events.  The ability to predict on non standard events with a reasonably small amount of money is something that Contracts for Difference can give.

Last Updated: March 4th, 2010