CFD

What are CFDs?

Contract For Difference, or CFD, is a derivative product which enables an investor to take advantage from the fluctuating price an underlying asset direct with their broker without ever owning the underlying asset. Investors are to speculate/trade on the difference in price of a financial market between when the contract opens and when it closes. The profit or loss you make depends on the extent to which your forecast is correct. Importantly, CFDs are a leveraged product. This means you only have to put down a small deposit for a much larger market exposure. Leverage comes with significant benefits and risks: your investment capital can go further, but you can also lose more than your initial deposit. While this means the product is very flexible, it also requires a high level of risk management.

CFD’s trading is available in a range of asset classes and markets and provides investors excellent leverage whilst still providing competitive spreads. The commission on a CFD is usually the spread of the asset as the difference in buy and sell price needs to be overcome in order to start to profit.

Why is CFD trading popular with investors?

CFDs are a popular way for investors to actively trade financial markets. This is because CFDs are:

CFD trading may be ideal for people:

What markets can you trade CFDs on?

We offer contracts for difference on over 1500 global markets and multiple asset classes, all with the ability to utilise leverage and go both long or short including:

Advantages of CFD trading

You can profit from both rising and falling prices.

If you believe the price of an asset is going to rise, you go long or ‘buy’ and you’ll profit from every increase in price.

If you believe the price of an asset is going to fall, you go short or ‘sell’ and you’ll profit from every fall in price. Of course, if the markets don’t move in the direction you expect, you’ll suffer a loss.

So, if you believe for example that Apple’s share price will fall in value, you simply go short on Apple share CFDs and your profits will rise in line with any fall in price below your opening level. However, should Apple’s share price actually rise, you would suffer a loss for every rise in price. How much you profit or loss will depend on your position size (lot size) and the size of the market price movement.

The ability to go long or short along with the fact that CFDs are a leveraged product makes it one of the most flexible and popular ways of trading short term movement in financial markets today.

Efficient Use of Capital

CFDs are leverages products enabling traders to increase their exposure to an underlying asset with a small initial outlay. When you open a trade you only need to deposit a percentage of the value of the position, this is known as margin. Your deposit will vary depending on the value of your CFD position. Leverage can result in added gains should the market move in your favour, however it also carries risks and can result in increased looses should your position move against you.

Hedging other Investments

The ability ‘go long’ as well as ‘go short’ with CFDs means that they are a great tool for hedging and existing portfolio. They are cost effective alternative to selling the portfolio prematurely and can be used to provide and ‘insurance’ against a price fall.

For example, if you have a long-term portfolio that you wish to keep, however you are of the view that there is some short term risk to the value of the portfolio you could use CFDs to ‘hedge’ your positions. If the value of the portfolio falls the profit you make on the CFDs will offset the losses in your portfolio.

Flexible contract sizes

The contract sizes of CFDs are often less than the typical contract size of the underling instrument, this means you can gain exposure to the price movement of the instrument without a significant deposit.

Access Global Financial Markets

CFDs allow traders access to a wide range of global markets that would otherwise be difficult to access. CFDs make it easy to trade commodities like Gold, Silver and Oil as well a variety of global indices without having to trade the futures contract itself.

Disadvantages

You should always consider your risk appetite and investment strategy prior to trading leveraged products. Leverage can work for you as well as against you and can magnify profits as well as losses. In the event of a significant move against you, you may loose more than your initial deposit. It is also important to be aware that you do not own the underlying instrument over which the CFD is based. Further information regarding the benefits and risks of CFD trading can be found in our Product Disclosure Statement.

Example of a CFD trade

If a stock has an ask price of $25.26 and 100 shares are bought at this price, the cost of the transaction is $2,526. With a traditional broker, using a 50% margin, the trade would require at least a $1,263 cash outlay from the trader. With a CFD broker, often only a 5% margin is required, so this trade can be entered for a cash outlay of only $126.30.

It should be noted that when a CFD trade is entered, the position will show a loss equal to the size of the spread. So if the spread is 5 cents with the CFD broker, the stock will need to appreciate 5 cents for the position to be at a breakeven price. If you owned the stock outright, you would be seeing a 5-cent gain, yet you would have paid a commission and have a larger capital outlay. Herein lies the trade off.

If the underlying stock were to continue to appreciate and the stock reached a bid price of $25.76, the owned stock can be sold for a $50 gain or $50/$1263=3.95% profit. At the point the underlying stock is at $25.76, the CFD bid price may only be $25.74. Since the trader must exit the CFD trade at the bid price, and the spread in the CFD is likely larger than it is in the actual stock market, a few cents in profit are likely to be given up. Therefore, the CFD gain is an estimated $48 or $48/$126.30=38% return on investment. The CFD may also require the trader to buy at a higher initial price, $25.28 for example. Even so, the $46 to $48 is a real profit from the CFD, whereas the $50 profit from owning the stock does not account for commissions or other fees. In this case, it is likely the CFD put more money in the trader’s pocket.

Buying a company share in a rising market (going long)

In this example, Company ABC is trading at 98 / 100 (where 98 cents is the sell price and 100 cents is the buy price). The spread is 2.

You think the company’s price is going to go up so you decide to open a long position by buying 10,000 CFDs, or ‘units’ at 100 cents. A separate commission charge of $10 would be applied when you open the trade, as 0.10% of the trade size is $10 (10,000 units x 100c = $10,000 x 0.10%).

Company ABC has a margin rate of 3%, which means you only have to deposit 3% of the total value of the trade as position margin. Therefore, in this example your position margin will be $300 (10,000 units x 100p = $10,000 x 3%).

Remember that if the price moves against you, it’s possible to lose more than your margin of $300, as losses will be based on the full value of the position.

Outcome A: a profitable trade

Let’s assume your prediction was correct and the price rises over the next week to 110 / 112. You decide to close your buy trade by selling at 110 cents (the current sell price). Remember, commission is charged when you exit a trade too, so a charge of $11 would be applied when you close the trade, as 0.10% of the trade size is $11 (10,000 units x 110p = $11,000 x 0.10%).

The price has moved 10 cents in your favour, from 100 cents (the initial buy price or opening price) to 110 cents (the current sell price or closing price). Multiply this by the number of units you bought (10,000) to calculate your profit of $1000, then subtract the total commission charge ($10 at entry + $11 at exit = $21) which results in a total profit of $979.

Outcome B: a losing trade

Unfortunately, your prediction was wrong and the price of Company ABC drops over the next week to 93 / 95. You think the price is likely to continue dropping so, to limit your losses, you decide to sell at 93 cents (the current sell price) to close the trade. As commission is charged when you exit a trade too, a charge of $£9.30 would apply, as 0.10% of the trade size is $9.30 (10,000 units x 93c = $9,300 x 0.10%).

The price has moved 7 cents against you, from 100 cents (the initial buy price) to 93 cents (the current sell price). Multiply this by the number of units you bought (10,000) to calculate your loss of $700, plus the total commission charge ($10 at entry + $9.30 at exit = $19.30) which results in a total loss of $719.30.

Trading CFDs can be a good money maker. That being said, as with all types of trading, you should ensure you have a good knowledge of the markets and all of its aspects to maximise the chances of profitability.