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. Institutions and hedge funds have utilised Contracts for Difference in the UK stock market for just over ten years instead of regular sharedealing. In many ways CFD trading is similar to spread betting in that both of them are margined products so you can gear yourself up or actually take a decision that is a multiple of your available funds.
So if you take 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 be used as margin to esablish new positions but any running losses would have to be made good by actually reducing your position or finding additional funds.
While 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 seemed to add to the 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 future profits for the purposes of tax. In the same way that you would buy shares, when you trade in CFDs the contract purchase is the same.. 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.
Most CFD providers admit you to post orders anywhere within the bid-offer spread whereas spread betting firms post their own two-way take it or leave it price exactly as a bookie would. Most CFD providers allow you to post orders anywhere within the bid-offer spread whereas spread betting firms post their own two-way take it or leave it price exactly as a bookie would. With CFD you are the price maker, which is why hedge funds tend 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 separately. Because of this, the CFD spread quote will forever 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. It’s important to note that they should not be regarded as substitutes for long term investment or saving, as more citizenry 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.
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