CFD trading, also known as Contract for
Difference, is the buying or selling of a share, index,
commodity or currency pair.
Unlike Futures trading the
contract created between the trader and the CFD Broker does
not have an expiry date but instead 'rolls over' at the end of each
day to create an ongoing position. Once the trader decides to close
the position, which is done by selling the asset if the original
trade was a buy, and buying the asset if the original trade was a
sell, there is a difference in price created between the opening
trade and the closing trade resulting in a profit or loss for the
trader.
A buyer will profit if the price they sell at is greater than the
original opening price and a seller will gain if they can buy at a
lower price than the opening trade.
When trading share CFD's the trade is placed in
a number of shares, for indices and commodities the trade is made
in lots (the size of each lot will differ depending on the broker
you use so it's very important to check with them prior to the
opening of a position) and for foreign exchange CFD
trading the trade is placed is the amount of the second named
currency in the chosen pair e.g if you are trading £ vs the $ you
will trade in a $ amount with your chosen broker.
The costs to trade CFD's will vary depending on
the provider you decide to use but in general the two main
charges are the commission to place the trade and the cost to 'roll
over' your position each day you wish to keep it open. Brokers
calculate the commission and rolling costs by multiplying the size
of the trade by the price you trade at. For example, if
you are buying 10,000 shares of Vodafone at a price of £1.70 your
commission and rolling charges are calculated on a 'consideration'
of £17,000 (10,000 x £1.70).
CFD
trading differs from a buying a
physical position with a stock broker where the total
value of the trade is required to be deposited with the broker (so
in the example above the stock broker would require £17,000 to be
deposited prior to the trade being accepted). CFD's are a
leveraged product allowing traders to deposit only a small
percentage of the total 'consideration'. For the bigger, more
liquid shares, brokers will sometimes require as little as 5%
of the total value allowing you to keep the remaining 95% in
an interest bearing account. This flexibility, combined with
the fact that this product does not incur Stamp Duty, has resulted
in a growing number of traditional share traders to move their
business into CFD's and this appears to be a trend that is likely
to continue for some years to come.