What is the nature of CFD trading?

Contracts for Difference also known as CFDs permit investors to trade shares actually owning them. The trader creates a contract with the broker. The trader will then bet on a particular stock price and whether that price will go up or down. He then considers how many shares he will bet on. If he is right then, when he chooses to close the contract he will be paid the difference between the starting price and finishing price times by the amount of shares in the contract. Should his estimate be incorrect and the markets turn against him, the trader will lose and must pay the broker the difference.

Loss or gain is made upon the difference between the price at which you purchase, and the price at which you vend. This is because CFDs are traded on margin. 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 are likely to pay approximately 10% of the stock you trade. The other 90% will be lent by the broker. Due to this, you will earn the profit if the markets go in your favour. However, if they turn against you, you will owe the broker the losses of the whole contract.

How does CFD trading work?

CFDs are financial products which give traders exposure to markets. However the costs involved are cheaper as you don’t need to own a share. Unlike a futures contract, there is no fixed size to the contract, and no fixed end date. Therefore, at the end of each trading day, the CFD can be rolled forward so the position is left open without an end date - as long as the investor account can support this.

How can you make money CFD trading?

CFDs can offer a number of different strategies; you can go long which means that the trader's account will receive a proportional payout when dividends are paid on the share, and interest will be debited.

You can also go short which means that the trader receives interest and pays dividends. Dividend payment will be an equal amount to the full dividend paid on the share.

Is it worth investing in CFDs in the long term?

Trading CFDs is not usually a long term investment and functions better as a short term investment. This is because they are traded on margin. The investor is charged interest on his or her bets - the longer the investor holds a CFD, the more the interest will increase and could become very expensive. Long CFDs carry interest charges of around 6.5% of the contract value.

Contract Value Explained

All CFDs have a contract value. This is the total value of the stocks you are 'betting' on. Trading is done on margin, so the broker will needs approximately 10% of the contract value. For example the investor is betting on 1,000 shares on a stock worth 200p - the contract amount would be 200,000p.

How much of a deposit is needed to start an account?

If you are opening an account the minimum deposit you will need is approximately £10,000 when based on FTSE 100 shares. However, there may be a larger minimum deposit required on foreign shares. CFDs can provide a lot of leverage and the sum of money you actually need to start is relatively low so you can trade more than your deposit. However, it must be remembered that this is risky.

Is it necessary to pay stamp duty?

You are not buying the underlying share so you so not have to buy stamp duty. There are also some brokers who offer 0% commission though most will charge 0.5% of the contract value when the contract is opened and closed.

What Interest payments are involved with CFD trading?

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.

Is CFD trading risky?

CFDs are risky for the investor you can make a lot of money but you are risk not only of losing your money but also owing the broker. There are numerous risks involved with CFD trading and these should be considered carefully by anyone wanting to invest in this manner.