Contracts for Difference (CFDs) Explained in Full

Depending where you are trading Contracts for Difference (CFD) in the world, there are a few common features of these leveraged trading instruments.

One main feature that traders choose to utilise when trading CFDs is their leverage. Instead of paying full value for the trading transaction, the trader only pays a percentage (a fraction) of the total position when opening the position – this is called the Initial Margin. This margin allows for leverage trading plays, which allows for increased exposure to the underlying share price movements unlike if you buy the underlying securities themselves.

Because Contracts For Difference are traded on margin and the prices of the underlying securities fluctuate during market hours, the dealers have something called Mark to Market. The margin is actively marked to the market price – which means the percentage is actively being calculated as the share price moves. You must keep a margin on all open positions over the required level including any market profits or losses (paper profits and losses) as long as the position is open. If the trading position moves against you and reduces your cash balance and you end up in the red below the required margin level you will receive a “Margin Call” and will need to fund the account to maintain the position otherwise your CFDs would be automatically liquidated.

A CFD can be Traded in Rising or Falling Markets

Trading in CFD allows the trader to easily take a long or short position on the market or any security that is provided by any CFD dealer. That means the trader can trade both rising and falling markets. You can profit when the share price goes up and you are long, and you can also profit when you have a short position and the underlying shares fall. When you buy the CFD with the expectation that the underlying shares will rise, you are taking a long position. When you sell or short sell the CFD with the expectation that the underlysing security will fall you are taking the short position.

No Stamp Duty, Tax Implications on CFD

Don’t take my word as gospel but depending where you are with trading CFDs, you aren’t physically buying the underlying shares or stocks so you don’t have to pay stamp duty. Other tax implications for trading CFD can be that you can register your trading activities as a business.

Commissions

Instead of a brokerage, CFD’s have commissions, which is basically the same thing. The CFD commission is calculated on the total position value and not just the margin paid.

CFD Overnight Financing

CFD’s have overnight financing. A consequence of the leverage is that you are basically borrowing money – and someone needs to be paid the interest. So when you hold a position open overnight you’ll get a finance charge for that benefit. Long CFD positions attract an interest charge of 1 to 2 percent above your national bank’s lending rate and short positions pay interest but 1 or 2 percent below your national bank’s official lending rate. This interest on the position is calculated daily with the application of the interest rate on the daily closing value of the position. (Daily closing value is the number of shares you hold and the closing price of the underlying shares).

Flexibility in Trading Market Sentiment

Trading Contracts For Difference offers the trader flexibility in trading market sentiment. There are CFD’s that allow you to trade specific shares, or market indices if you have an overall market sentiment or even sectors and specific international currencies.

CFD and Risk Management

CFD providers commonly provide risk management facilities because of the high risk nature of leveraged trading and the double edged sword effect. Many of these CFD dealers provide Stop Loss, Limit Orders and If Orders so market traders can actively manage their risk in trading CFD’s.

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