CFDs explained

 

CFDs or Contracts for difference is simply an agreement to exchange the difference in value of a financial instrument between the time at which the contract is opened and the time at which it is closed.

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What are CFDs ?

A CFD is simply an agreement to exchange the difference in value of a particular share (or other financial instrument) between the time at which the contract is opened and the time at which it is closed. In the case of share CFDs, unlike a traditional share, when you open a position you are not required to pay for the full value of the trade but rather you are required to deposit collateral. This is known as the Initial Margin, which can be as low as 5% of the purchase price. In recent years there has been a dramatic increase in the use of CFDs, they have in a short space of time become the instrument of choice for short term stock market investors. If you are not interested in high risk investments then it is probably safe to say that CFDs are not suitable for you and we would strongly advise that you do not attempt to trade these products.

Benefits of CFDs 

Long and short positions 

CFDs allow you to take advantage of rising and falling markets  

No stamp duty to pay

Unlike most UK shares there is no stamp duty to pay.

Small initial deposit

Only pay a small percentage of the trade value.

Speculate on price movements

Spread betting and CFD products allow you to take a position on a market price without owning the underlying asset. 

Competitive spreads

Helps keep your costs of trading down.

Negative balance protection (2)

You can never lose more than is in your account.

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Key features of CFDs 

Traded on Margin
Rather than pay the full value of a transaction you only need to pay a percentage when opening the position. This is referred to
as ‘Initial Margin’. The key point is that the margin allows leverage, so that you can access a larger amount of shares than you would
be able to, if buying or selling the shares themselves. The margin on all open positions must be maintained at the required level
in order to keep the position open. If a position moves against you and reduces your cash balance so that you are below the
required margin level on a particular trade, you will be subject to a ‘Margin Call’ and will have to pay additional money into your
account to keep the position open or you may be forced to close your position.


Trade in Rising or Falling Markets
CFDs allow you to trade ‘Long’ or ‘Short’. A Long trade is where you ‘Buy’ an asset with the expectation that it will rise, just as you
would when buying a normal share. A Short trade is where you ‘Sell’ an asset that you do not own in the expectation that the
price will fall and you can Buy the asset back at a cheaper price.


No Stamp Duty
There is no stamp duty on CFDs as you do not actually Buy the
underlying share*.
*Tax laws may change

Commission
Commission is charged on CFDs just like on an ordinary share trade. The commission is calculated on the total position value not
the margin paid.


Overnight Financing
Because CFDs are traded on margin, if you hold a position open overnight it will be subject to a finance charge. Long CFD positions
are charged interest, Short CFD positions will be paid interest. The rate of interest charged is set at 2.50%** above or
below the current LIBOR (London Inter Bank Offered Rate). The interest on each position is calculated daily by applying the applicable interest rate to the daily closing value of the position. The daily closing value is the number of shares multiplied by the closing price. Each day’s interest calculation will be different unless there is no change in the share price.

** Subject to change


Shares and Indices
CFDs allow you to take a view on shares and indices as well as some sector specific indices (such as Mining). 


Risk Management Facilities
We place strong emphasis on risk management techniques. Robust risk management to protect profit and limit downside risk
is as important as placing the trade. Because of the higher risk nature of trading on margin, we can offer comprehensive ‘Stop Loss Order’ and ‘Limit Order’ facilities so that investors can manage risk in fast moving markets.

Share CFD example long trade

A Long trade is when you Buy a share CFD


Marks and Spencer is trading at 240–240.25p
You believe that Marks and Spencer’s share price is going to rise and place a trade to Buy 5000 shares as a CFD at 240.25p.
The value of the contract would be £12,012.50, but you would only be required to make an initial deposit of 7.5% (Initial Margin of £900.94.


The commission on the trade is £12.01 (£12,012.50 x 0.1%) unlike a traditional share there is no stamp duty payable.
 

10 days later Marks and Spencer is trading at 270–270.25p
You decide to close your position and take a profit by selling 5000 Marks and Spencer at 270p which equates to £13,500.
The commission on the trade is £13 .50 (£13,500 x 0.1%).

Profit on trade is calculated as follows:

Of course if the market had moved against you, you would have made a loss.

Share CFD example short trade

Share CFD example Short Trade

A Short trade is when you Sell a share CFD


Marks and Spencer is trading at 300–300.25p
You believe that Marks and Spencer’s share price is going to fall and place a trade to sell 5000 shares as a CFD at 300p. The value of the contract would be £15,000, but you would only be required to make an initial deposit of 7.5% (Initial Margin) of
£1,125.


The commission on the trade is £15 (£15,000 x 0.5%).


10 days later Marks and Spencer is trading at 280–280.25p
You decide to close your position and take a profit by buying 5000 Marks and Spencer at 280.25p. The commission on the trade is £14.01 (£14,012.50 x 0.1%).


Profit on trade is calculated as follows:

Of course if the market had moved against you, you would have made a loss.


In this example by being Short M&S, interest payments are credited to your account.

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Indices CFD example long trade

FTSE 100 at £10 a point

The FTSE 100 is currently trading at 7792 and the quote is 7791–7793 on the FTSE CFD.

You believe that the FTSE is going to rise and Buy 1 Maxi Index CFD at a total value of £77,930.

To open your position you supply a deposit of £3896 per Maxi Contract. Later that day FTSE has risen to 7991 and the daily FTSE spread is now 7990–7992.

You decide to close your position and take a profit by selling 1 Maxi Index CFD which equates to £79,900.

 

The profit on the trade is calculated as follows:

To calculate the overall profit you must take into account the financing charges on the deal.


Of course if the market had moved against you, you would have made a loss.

Indices CFD example short trade

FTSE 100 at £10 a point

 

The FTSE 100 is currently trading at 7400 and the quote is 7399–7401 on the FTSE CFD.

You believe that the FTSE is going to fall and sell 1 Maxi Index CFD at a total value of £73,990.

To open your position you supply a deposit of £3699 per Maxi Contract. Later that day FTSE has fallen to 7299, spread is now 7298–7300.

You decide to close your position and take a profit by buying 1 Maxi Index CFD which equates to £73,000.

 

The profit on the trade is calculated as follows:

To calculate the overall profit you must take into account the financing charges on the deal.


Of course if the market had moved against you, you would have made a loss.

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Limit and stop loss orders

Because of the geared nature of trading on margin it is essential to have access to facilities that let you open or close positions if certain levels are reached.


Limit Order
A Limit Order is one that is executed at a better price than the prevailing market price, i.e. for a Long CFD trade when the stock drops to a certain level or for a Short CFD trade when the stock rises to a certain level.

Example
BT Group is trading at 180–180.5You want to Buy 10,000 BT Group as a CFD with a Limit of 175p, therefore you do not wish the Order to be opened unless BT Group reaches 175p.This Order is held by the CFD Provider until the Limit level is reached. The next day BT Group is 174.5–175 and an opening trade of 10,000 BT Group is executed at the Limit level of 175p.


Stop Loss Order
A Stop Loss Order is one that is executed at a worse price than the prevailing market price. A Stop Loss Order is a price level set by the client on a particular trade, that if reached, automatically closes out the particular position at the desired price. It is possible to make substantial profits when trading CFDs as well as substantial losses which is why we may recommend you consider placing a Stop Loss Order when you trade.

Example 
BP is trading at 467–468
You believe that BP will rise and you Buy 2,000 BP at 468p as a CFD. You want to limit your potential losses as the markets are currently very volatile. You place a Stop Loss Order which will close out your position at 450p. The following day BP drops steadily to 420–421 and you are not able to watch the market. Your position is closed at 450p limiting your loss to £360, had you not placed a Stop Loss your losses would be running at £960.

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  1. Our platform provider IG is the UK's No 1 provider by number of primary relationships with FX traders (Investment Trends UK Leveraged Trading Report released July 2019).

  2.  Negative balance protection applies to trade related debt only and is not available to professional traders.

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Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 76% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money. Professional clients can lose more than they deposit.

 

All trading involves risk.

The value of shares, ETFs and ETCs bought through a share dealing account, a stocks and shares ISA or a SIPP can fall as well as rise, which could mean getting back less than you originally put in. Past performance is no guarantee of future results.

The information on this site is not directed at residents of the United States, Belgium or any particular country outside the UK and is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

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