What are CFDs ?

CFDs are an agreement between you and a broker to exchange, at the closing of the contract, the difference between the opening and closing prices, multiplied by the number of shares in the contract.

You predict whether the price will rise or fall and invest money on this basis. You take a long position if you think the price will rise, or take a short position if you think the price will fall. You make a profit or a loss depending on whether you have correctly predicted the direction in which the price will move. This means you can make money even if the price of a share falls, if you have predicted correctly and 'gone short'. Going short means that you sell stock you don't own then buy it back later, hopefully at a lower price to realize a profit.

In CFD dealing, you do not physically buy or hold the physical underlying share; you only have indirect access to the price performance. However, you would benefit from a dividend payment when going long.

Margins and gearing

CFDs are dealt on a margin basis, and you secure the transaction by paying a deposit, also known as a Notional Trading Requirement,(NTR) of around 10% of the contract value. So if you wanted to undertake a contract worth £20,000 you would need an NTR of £2,000. The understanding is that you must be able to cover the entire contract value and any associated costs if the price moves unfavourably. You must also be able to maintain the required margin, which may involve topping up the deposit if the level of exposure increases during the period of the contract.

The benefits of margin trading are that if you make a profit, you haven't had to make a full outlay of capital, you are able to take a much larger position than you would normally be able to, and there is the potential of significantly greater profits than traditional share dealing (also known as 'gearing').

However, you should note that gearing also means that the potential for losses is equally increased. Because of this, before dealing in CFDs. You should consult an independent financial adviser, if you are unsure whether CFDs are a suitable investment for you.

Trading Strategies

Because of their nature, it is possible to use CFD dealing strategically, in several ways. Some investors use CFDs for the ability to deal on a margin basis, with no stamp duty to pay make CFDs attractive for investors hoping to benefit from short term price movements. Pair trading is another example where  an investor takes a long CFD in a company who they believe is undervalued while going short on another more expensive share in the same sector .

Hedging investors can use CFDs to hedge against price falls in existing shareholdings. Investors can take out a short CFD in the shares rather than selling the actual shareholding to buy them back later, and this often proves to be less expensive. If the share price falls, then investor would lose money on the shareholding but make money on the CFD. If the share price goes up, then although the investor would lose money on the CFD,. the shareholding would have increased in value.

CFDs enable tax-efficient trading.  Investors who have an existing holding in a company can sell CFDs against this, allowing them to control the time at which they crystallise capital gains or losses, especially useful around the end of the financial year.

Risk Warning

CFDs  carry a high risk to your capital as they are leveraged instruments  and therefore may  not  be suitable for everyone and are aimed generally at the professional spectrum of traders which include hedge funds, private equity, and sophisticated traders. Any persons wishing to trade such  instruments  should fully understand the  logistics of how leverage and margined products operate. If you are uncertain  if CFDs are right for you, seek professional investment advice. In this fast paced world its far too easy to make losses  than to profit from these instruments ,however with a common sense approach they can also offer a very attractive reward. We hope you find this website informative and on a regular basis it will be updated.