Contracts for difference (CFDs) are agreements between two parties to exchange the difference between the opening and closing price of a contract. There are long and short parties - a long party buys the CFD while a short party sells it. CFDs offer margin flexibility and the ability to go long or short without stamp duty. They can be traded on stocks above certain market capitalizations. The profit or loss from the difference in prices is returned to the parties when closing, plus or minus any interest charged for using margin. Trading rules include only risking money you can afford to lose and using stop losses.
2. What is a CFD?
An agreement:
between two parties to exchange, at the
close of the contract, the difference between
the opening and closing price of the
contract
multiplied by the number of shares
specified with the contract.
3. Parties in a CFD
transaction
There are always two parties:
• The LONG party
An investor who opens a position by BUYING a CFD
• The SHORT party
An investor who opens a contract by SELLING a
CFD
4. Why CFDs v. Physical
Shares?
• Margin Flexibility (CFDs are traded on margin)
i. You can take positions in the market 5 times
greater value than your normal cash trade, or …
ii. You can trade your normal size and deposit only
20% of the value as initial margin
• Long or short
i. BUY stock (go LONG), or …
ii. SELL stock (go SHORT)
depending on your market sentiment
5. Why CFDs v. Physical
Shares?
• No stamp duty
As you are not buying physical shares, you are
not liable for stamp duty (under current UK
legislation) = save ½% per trade
6. What stocks can I trade?
CFDs can be traded on all stocks
with a market capitalisation above:
• UK = £50 million market cap
• European = €100 million market cap
• US = $1 billion market cap
7. How do CFDs work?
Normal Share Trading:
BUY SELL
OPEN 10,000 shares 10,000 shares
TRADE
CLOSE TRADE 10,000 shares 10,000 shares
CFD Share Trading: LONG SHORT
BUY SELL
OPEN 10,000 shares
TRADE
OR OPEN TRADE 10,000 shares
… open trade on buy side or sell side
8. Dividends
• Dividends still apply even though
you do not take physical delivery
9. How does Margin work?
Stage 1 Account value £100,000
Stage 2 Open a £50,000 trade
(requires £10,000 as a 20% good-faith deposit)
Stage 3 Left to trade: Initial Margin Variation Margin
£90,000 £10,000 £ profit/ loss
real-time
Stage 4 Close position
- Profit/ loss returned with initial margin
£90,000
+ £10,000 Initial Margin
+/- £ profit/ loss
10. Costs
• Commission
Every trade accrues a commission charge
• Interest
As your broker is funding 80% of the contract
value, you pay or receive a minimal interest charge
i. Long positions – you pay a spread over LIBOR
on the 80%
ii. Short positions – you receive a spread under
LIBID on the 80%
11. CFD Trading Rules
• Trade with money you can afford to lose
• Do NOT over leverage
• Risk Management – make sure trades are at least 2:1
in your favour
• Use STOP LOSSES – limit your downside, only
moving a stop loss to REDUCE risk
• Know your entry AND exit levels before executing a
trade
• DISCIPLINE – develop out a system that works for
you and stick to it