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CFD TRADING - Frequently Asked Questions

Please find below more information CFD Trading. Just click on the links to get more information.

        

What are CFDs?

Contracts for Difference - or CFDs - allow investors to trade shares without actually owning them. The trader makes a contract with the broker. The trader then bets on a certain stock price and what direction it will take. He then decides how many shares he will bet on. If he wins - if he's correct on the bet - then, when he chooses to close the contract he will be paid the difference between the opening and closing price, multiplied by the amount of shares in the contract. Should his bet be incorrect and the markets turn against him, the trader will lose - he must pay the broker the difference.

So, the profit or loss is made on the difference between the price at which you buy, and the price at which you sell. This is because CFDs are traded on margin. Therefore, investors don't need more than a small amount of the total value of a position in order to trade.

CFDs are made on margin. So, if you buy a CFD you will pay around 10% of the stock you are trading. The remaining 90% will be lent by the broker. Therefore, you will earn the profit if the markets go in your favour. Should they turn against you however, you will owe the broker the losses of the entire contract.

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How do CFDs work?

CFDs are financial instruments that offer the investor exposure to markets, but at a small percentage of what it costs to actually own a share. Unlike a futures contract, there is no fixed size to the contract, and no fixed expiry date. Therefore, at the end of each trading day, the CFD is either rolled forward so the position is left open without an end date - as long as there is enough margin in the investor account to support this.

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What Strategies are Available?

CFDs give the trader a number of strategies , the most commonly used are:

Long - this means the trader's account will receive a proportional payout when dividends are paid on the share, and interest will be debited.

Short - this is the opposite, so the trader receives interest and pays dividends. Dividend payment will be an amount equal to the full dividend paid on the share.

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Are CFDs a Worthy Long Term Investment?

CFD trading is best as a short-term investment. This is because they are traded on margin. The trader is being charged interest on bets - the longer the trader holds a CFD, the interest will mount up and could become expensive to keep up. Long CFDs carry interest charges of around 6.5% of the contract value.

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What is Contract Value?

Each CFD has a contract value. This is the total value of the stocks you are 'betting' on. As mentioned, trading is done on margin, so the broker will require around 10% of the contract value. Let us imagine the trader is betting on 1,000 shares on a stock worth 150p - the contract value would therefore be 150,000p.

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How Much Do I Need to Open an Account?

When opening an account, the minimum deposit required is usually around 10,000 when based on FTSE 100 shares. There may be a higher minimum deposit on lesser-known shares or overseas shares.

Therefore, CFDs allow much in the way of leverage - the amount of capital you actually need to begin is relatively low. Therefore, you can trade more than your deposit. This does expose you to a large and grave risk - see CFD Risks.

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Do I have to Pay Stamp Duty?

CFDs do not require the investor to pay stamp duty. This is because you are not actually buying the underlying share.

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Do I have to Pay Commission?

It depends. Some brokers offer zero commission. Usually though, traders are charged 0.25% of the contract value at opening and closing of a CFD.

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What Interest Payments Are There?

You will be charged interest if you choose to go long on a stock, as you are borrowing money from the broker. You will earn interest on a short stock. Interest is either paid or earned on a daily basis, and is calculated by dividing the annual interest rate by 365.

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What are the Advantages of CFDs?

  • Easy to use.
  • There is no fixed size to the contract.
  • You can trade under any time frame.
  • Strategies are are easy to carry out.
  • Whether trading long or short.
  • Earn interest on short positions.
  • Earn dividends on long positions.
  • Participate in other activities such as share splits and dividends.
  • No stamp duty.

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Are there any Disadvantages?

  • Not good for long term investment.
  • Risk huge losses.
  • You could lose lose more than the amount you originally invested.
  • Volatile market.

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What are the Risks?

CFDs expose the trader to high risks - while you can make significant wins, you are also at a great risk of not only losing the initial deposit you made, but you may end up making additional payments to the broker.

Because the risks to CFD trading are numerous, we have outlined them in a separate document - CFD Risks. Traders or prospective traders are urged to familiarise themselves with Risks before commencing trade.

More Information on CFD Trading Risks

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Can I Reduce Risks?

Aside from familiarising themselves with the significant risks in CFDs trading, traders can exercise a stop loss function.

A stop loss function mean that if a pre-determined loss is reached, the trade is closed - meaning further losses are prevented. However, guaranteed stops are not available on all indices and shares. There may also be additional charges on these orders - so it is much like an insurance premium.

Another way to reduce risk is to make smaller amounts, or to trade on a smaller margin.

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