The definition of a CFD (or Contract For Difference) is an agreement to exchange the difference in value of a particular market between the time at which the contract is opened and the time at which it is closed.
CFDs are one of many forms of investing and trading FX, Commodity and Stock Index markets, regulated by the UK’s Financial Conduct Authority (FCA).
How Does it Work?
With CFDs you do not actually own the underlying asset that you are trading because it is a derived instrument. The prices that we provide you are derived from the underlying asset and these prices move in conjunction with that underlying asset.
This diagram shows how your profit is calculated depending on whether you buy or sell the market, assuming you buy 1 CFD:
Once you have chosen the market on which you wish to trade, you can then trade as many CFDs as you wish, which will represent your profit or loss per point movement in that market (each market has its own individual maximum allowable trade size).
You can choose to bet that the market will rise (Buy or Go Long), or alternatively, you can bet that it will fall (Sell or Go Short). If you are right, you will make a profit of your number of CFDs multiplied by each point that the market moves in your favour. If you are wrong you will make a loss of your number of CFDs multiplied by each point that the market moves against you.
For this reason you must be aware that your losses can increase dramatically if the markets move substantially in the opposite direction to your trade (i.e. if you BUY ABC 100 and instead of going up it goes down).
In all markets, there is a “spread” which refers to the difference in Sell (Bid) and Buy (Offer or Ask) price quoted by a broker. A CFD price always has two parts. The first is the BID or price you can sell at. The second is the ASK or the price you can buy at. This price is calculated by adding additional points around the live (or the estimated future) market price of a financial product. For example, if the Daily FTSE is betting at 5000.5 our quote might be 5000.0-5001.0.
CFD Trading compared to Stocks.
Traditional Stock Broker
|ROCE working: 4750 ÷ 14000 x 100%|
|Buy 10,000 shares @||140p|
|Sell 10,000 shares @||200p|
|Tax @ 18%||(£1,080)|
|Return on Capital Employed||34%|
|ROCE working: 4873.6 ÷ 1401 x 100%|
|Buy 10,000 CFDs @||140.1p|
|Sell 10,000 CFDs @||199.9p|
|Tax @ 18%||(£1,076.4)|
|Return on Capital Employed||347%|
** CFD’s are exempt from UK Stamp Duty. Tax treatment depends on the individual circumstances of each client and may change in the future.
Remember that the risk is still the same for either scenario.
As with all CFDs you do not own or owe the underlying asset. So, if you open a buy CFD on a share you will not have any voting rights.