Thursday 15 November 2012

CFD’s - (Contract for Difference)



Wow, it been a long time since my last blog post. This is because I was busy with exams. So this week I am talking about CFD’s.  Let me first define what a CFD is. A CFD (Contract For Difference) is a deal which happens between two parties where one party is the buyer and the other is the seller where the settlement is a difference in monetary terms on the underlying instruments (which is used as a reference).  So the buyer doesn’t actually purchase the financial instrument. The buyer then takes advantage of the market as when the price differential in the underlying instrumental difference increases. So the buyer is making a profit.  A CFD is a derivative, consider a financial instrument then the derivative is the market price of that financial instrument derived from underlying assets.

When I first read up about CFD’s I said to myself this is just like a futures contract. It turned out they are like futures but there are some major differences. I have listed the biggest key differences between the two below:

  • CFD’s generally have smaller contract sizes although they can be bigger if you want them to be 
  • They don’t have a contract expiry date
You can trade on margin which is if you are low on funds you can buy a lot of shares effectively by borrowing money (leverage) but you have to deposit an amount to cover the risk that you may not be able to pay it back to the broker/exchange. When you buy these “shares” (under CFD’s you don’t actually own shares) you are charged a lending rate which is the LIBOR rate. In general, there is a financial cost everyday, whilst your trade is live overnight you can calculate this charge by using the equation given below:





When you close your trade you pay commission charge which is typically 0.1%.

Just like trading any other securities you can go long or go short, however you can trade any product you wish, from indices, commodities, Forex and energies. When going long, the LIBOR rate is added to your broker margin percent. However when going short if the LIBOR > (greater than) broker margin percent then you are credited, but if the LIBOR < (less than) broker margin percent than you are debited.

If you placed a trade to buy shares in a company in the FTSE 100 then any profits or losses these will be put on a rolling contract. A rolling contract for a CFD basically means that any profits/losses will be credited/debited to your account and the profits/losses are realised.

So what are the benefits of CFD’s

  • They are versatile and the market is 24 hours a day, so you can buy it when the FTSE closes or the DAX closes
  • You don’t need a lot of money to start trading CFD’s
  •  If you buy long on equities before the ex-dividend date then your account is credited with the dividend payout for each share after the market closes. Do bear in mind that Financial charge may outweigh this.
  • You don’t need to physically own the instrument to trade, this also means that you do not need to pay stamp duty and capital gains tax, HURRAY!!
  • Just like trading any other financial instrument


CFD’s in a sense is basically like spread betting you are in a sense placing a trade on the outcome of the market, and you also incur a financial charge for every night the trade is live for. In addition the valoume of trading CFD's has significantly grown over the years.

How do you trade CFD's

You trade CFD’s not over the phone but via electronic trading, this is done over the internet. You can do it from home using the software given to you by a broker or now you can do it online with no software but some sites require you to install Java. In addition, electronic trading ensures that the trade is executed in less than a nanosecond, so you don’t miss out in the action. Over the phone whilst talking to your broker, prices would fluctuate whilst you talked, hence electronic trading has helped smooth out this so called “insider information.” Electronic trading has developed a lot over the years from algorithmic trading to high frequency trading. 

I hope you found this post informative and I hope this at least provides a foundation for trading CFD's. The blue words in the text, when clicked provide more information on the word. This post is intended to educate the reader.

Please note this is my opinion and he/she (the reader of this post) should not place a trade with the information provided in this post as this may result in a loss for the individual. I will not be held responsible for the loss you make. The data presented may be inaccurate/incomplete and will be inaccurate due to the nature of financial markets 

2 comments:

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  2. Good one... This blog nicely explain CFD definition, benefits and how to trade CFD. Thanks for sharing.

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