CFD Trading Explained, Simply
Posted by forexauthor - 03/01/10 at 03:01 amA Contract for Difference, or CFD is an two way trading deal between two different parties based on the rise or fall in the trading price of an agreed number of shares in a company over an agreed time – no actual share purchase is necessary. Sounds complicated, but its not really. Institutions and hedge funds have utilised CFD Trading for over ten years now within the UK stock markert as an alternative to traditional share trading. They are many similar comparisions between CFD trading and financial spread betting in that both of these are margined products so you can gear yourself up or actually take a decision that is a multiple of your available funds.
So think about it from the point of a margin on a firm youre interested in, if it was 10% establishing a position of £100,000 would really only require a deposit of £10,000. Any running profits that you make can actually be used as margin to esablish new positions but any losses would have to be made good by reducing your position or by providing extra funds.
While stamp duty of 0.5% on all UK share purchases has in the opinion of some traders reduced the cost effectiveness of ‘day-trading’ traditional stocks and shares, both CFDs and spread betting are exempt and this has added to their appeal. CFDs are liable to capital gains tax whereas spread bets are tax free, but losses incurred from spread bets are gone for good while CFD losses can be offset against future profits for the purposes of tax. In the same way that you would buy shares, when you trade in CFDs the contract purchase is the same.. So if you wanted exposure to 1,000 shares in a company, youd have to sell 1,000 contracts at, say, 494p per contract rather than simply placing a £10 per point bet with spread betting to get a similar return.
Most CFD providers admit you to post orders anywhere within the bid-offer spread whereas spread betting firms post their own two-way take it or leave it price exactly as a bookie would. With CFD you are the cost maker, which is why hedge funds tend to use CFDs rather than spread betting. CFDs do not wrap the costs of financing a position within the spread (as does spread betting) but charge those costs and commissions on an individual basis. With CFDs the charges and commissions involved in a trade are not part of the spread, which is the case with financial spread betting. Because of this, the CFD spread quote will forever be very close to the underlying price of the share or commodity that you are following. CFDs also mimic nearly every aspect of owning the underlying share or market, so if you hold a position for a long enough time period you will recieve the benefit from any dividends being paid on the shares.
CFDs and spread betting have particular features that will appeal to different trading styles and there is no one best instrument to use. It’s important to note that they should not be regarded as substitutes for long term investment or saving, as more citizenry seek to take control of their financial destiny, theres been a growing realisation that going short is a legitimate means of trading in market thats become increasingly difficult to profit from in a traditional sense.
