Contracts for Difference - CFDs TRADING

What are CFDs?

Contracts for Difference - or CFDs - allow investors to trade shares without actually owning them. 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.

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.

What are my Options?

So, let us say you have decided to keep the contract open. You have two options: to either "long" or "short" a position. You will notice your account is either debited or credited according with dividend adjustments and interest. If you have chosen to "long" the position, you will receive dividends but pay interest, and if you have chosen to "short" the position, the reverse will happen. You can close the contract at any time, and commission is paid on either side.

It is wise to keep an eye on CFDs as you may be paying for each day the position remains open - that is, if you chose to go "long". So, after time, this could become expensive to maintain. Therefore, it is best to keep an eye on it and be prepared to cut the position. They are best for short-term trading, and you will need to be market-savvy.

What are the Advantages of CFDs?

There are many advantages to CFDs - they are easy to use, there is no fixed size to the contract, you can trade under any time frame, and your options are easy to carry out - whether trading long or short.

You receive interest on short positions, and on long positions you receive dividends. You can also participate in other activities such as share splits and dividends, so you have plenty of options. One major advantage to CFDs is the fact that the cost of a transaction is low - interest is the only additional cost on a long position and on a traditional purchase of a share, you will pay stamp duty of 0.5 per cent.

Are there any Disadvantages?

As with any trading tools, there are a few setbacks to CFDs. Yes, they easy to access and the fact that not a huge amount of capital is required is very appealing, but these factors can lead to over-trading. If you don't keep an eye on them, you may suffer under the market moving against you - and you may be required to add more money or sell down your assets.

That said, as long as investors don't "buy and forget" on CFDs and are prepared to keep an eye on their contracts, they can benefit a great deal from excellent returns.