Contracts For Differences, or CFDs, are a low cost alternative to traditional dealing. With the same initial investment, CFDs enable you to do more with your money than regular dealing, and your profits could be much greater, as would your losses should your trade go against you.
A CFD is an agreement to exchange the difference between the opening and closing price of an asset at a point when the CFD is closed. In traditional share dealing, for every point the profits of an asset you own moves up, your profit increases. For every point it moves down, you make a loss.
A CFD trade however, allows you to choose to go long or short, giving you the potential to profit from rising or falling markets. By not owning the underlying share itself, you currently do not need to pay stamp duty.
Let’s take a closer look at some of the features. All CFD trades are leveraged. This means that you only need to deposit a small fraction of an assets total value to place a CFD. For example, if you wanted to trade £10,000 worth of Vodafone shares, you would only need to initially deposit as little as £500.
It is important to understand the effect leverage has on your trading. Your trading can result in losses that exceed your initial deposit. You can place a position regardless of whether you think the market will move up or down. This is called going long or short. Going long by speculating that the market price will go up and your profits will rise in line with that increase. Similarly, your losses will increase as the price falls. Or go short, expecting that the price will fall in value, and your profits will rise as the price falls, while your losses will increase as the price rises instead. CFDs can be used as insurance to protect against other potential losses by using them to hedge. If you foresee a short term risk in your long term investments, the profit you make from a short CFD trade on the same market may offset the loss to your long term portfolio.
Placing CFDs with CMC markets gives you access to lots of markets including equities, stock indices, sectors, currencies and commodities. This is another example of CFDs flexibility.
Placing a CFD is relatively easy.
Step 1: Select a market.
This can be any one of over fifteen thousand markets, from a stock index like the FTSE 100, to commodities such as gold or oil.
Step 2: Buy or sell.
If you expect this market to rise you will choose buy and your profits will rise with any increase on the price. Similarly, if you expect the market to fall choose sell, and your profits will rise with any fall. Remember, you incur losses if the market moves against you.
Step 3: The price.
CFD prices are quoted in just the same way as underlying markets: as a bid – the price you can sell at, and as an offer – the price you can buy at.
Step 4: The margin.
This is the deposit you must initially have in your account prior to placing a CFD trade. This will be a percentage of the total trade value and is based on current market conditions. You must have sufficient funds to cover the market requirements for all your open trades.
Step 5: Stop loss and limit orders.
As CFDs can amplify profits or losses you may choose to place stop loss and limit orders on a trade to manage your profit and loss targets. These allow you to automatically close a trade, cutting your losses if an asset falls below a certain value or cashing out your profit once your goal is reached. Stop loss and limit orders can keep your trades manageable and efficient.
Step 6: Commission charges.
A small commission is charged on each equity CFD trade. This charges varies according to the platform you are working with.
If you place a CFD trade on a non-equity market, such as an index or currency pair, you are not charged commission. Instead, the spread between the sell and buy price is wider.
Step 7: Monitor your trade.
Using a trading platform, you can easily visualise all your currently open trades online and on your mobile.
And finally close your trade when you have reached your profit goals.