Classed as an emerging market, India is arguably a land of opportunity from an investment point of view. Financial instruments such as Contract for Difference (CFD) are available in the Indian market and trading is legal but unregulated, and as such Indian brokers are unlicensed.
The Securities and Exchange Board of India (SEBI), a regulatory body overseeing the stock exchanges and financial institutions in the country, currently has no legal framework to govern CFDs.
Right now, however, traders tend to use brokers in other jurisdictions where regulation is more prominent and the brokers are licensed.
What is CFD Trading
CFD trading, or Contract for Difference trading, is a method that allows individuals to speculate on the price movements of various financial markets, such as stocks, commodities, or indices, without the need to own the underlying assets. This form of trading involves an agreement between a trader and a broker to exchange the difference in the value of a specific asset from when the contract is opened to when it is closed.
The primary appeal of CFD trading lies in its flexibility to allow for both long (buying) and short (selling) positions. This means traders can profit from both rising and falling market prices. A long position is taken with the expectation that the asset’s price will rise, while a short position is based on the anticipation of a decline in the asset’s price.
A distinctive feature of CFD trading is the use of leverage. Leverage allows traders to gain significant market exposure with a relatively small initial capital outlay. For example, with leverage of 1:10, a trader can control a position worth $10,000 with just $1,000 of their own capital. However, it’s crucial to understand that leverage not only magnifies potential profits but also potential losses. This means that while traders can achieve larger gains if the markets move in their favor, they can also incur losses that exceed their initial investment.
Moreover, the concept of a margin call is vital in leveraged trading. If a market moves unfavorably and the value of the position falls below a certain level, the broker may require the trader to deposit additional funds to maintain the position. This aspect underscores the need for careful risk management in CFD trading.
As such, should the trader go for a short position and prices rise, then the trader could find they are looking at the prospect of unlimited losses and possible liquidation of their position.
CFDs are flexible as they do not have set expiration dates. This allows traders to close their positions at their discretion, subject to market conditions.
Unlike traditional investing, there is no ownership of the asset.
CFD Trading in India:
- Regulations Under Development: The SEBI can easily launch a governing framework unfavorable to CFD investors as easily as a favorable one. It is a case of watch and see and uncertainty is rarely a good friend to an investor. Arguably, CFD investment could also be more prone to fraud.
- Seasoned Investors Only: Given the newness of CFDs in India it is fair to say that only seasoned investors should dip a toe in the water. It is not easy keeping track of factors that influence price in a long established market. The Indian market adds a further set of factors to monitor.
- Unproven Brokers: It is fair to say that a good brokerage is worth its weight in gold. India’s brokers are yet to prove their weight in the CFD game. This adds to the investment risk.
CFD trading offers an alternative way to participate in the financial markets. While it comes with its set of challenges and risks, particularly around leverage and short positions, it also opens up opportunities for those willing to engage in comprehensive research and risk management. As the Indian market continues to develop, CFD trading could become an increasingly significant part of the investment landscape.