A 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. Many investment groups and hedge funds have found a great deal of success with CFD Trading for over ten years now within the UK stock markert as an alternative to traditional share trading. In many ways CFD trading is similar to 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 for example the margin on a firm youre interested in 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 the 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 any future profits for the purpose of tax. When you trade in CFDs, you purchase those contracts in almost the same way that youd buy shares. Let’s say you wished to invest on a thousand shares in a business – with CFD trading you would need to sell 1,000 units at eg 494p per share, whereas with spread betting you would just place a bet of £10 per point to get an equivalent return.
The other difference between the two instruments lies in the flexibility in the bid-offer spread. With CFD you are the price maker, which is why hedge funds incline 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 individually. CFDs do not wrap the costs of financing a position within the spread (as does spread betting) but charge those costs and commissions separately. Because of this, the CFD spread quote will always be very close to the underlying price of the share or commodity that you are following. CFD’s also mimic almost every aspect of actually owning the underlying share or market, so if you hold a position long enough, you receive the benefit of any dividends being paid on the underlying shares.
CFDs and spread betting have particular features that will appeal to different trading styles and there is no one best instrument to use. Although they should not be regarded as substitutes for long term investment or saving, as more people 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.
