Contracts for difference

1  2  3  4  5  6  7  8  9  10  11  12  13  14  15  16   

2. The benefits of CFDs

Until recently, CFDs were the preserve of institutional investors who used them to minimise the costs of stock lending. Their popularity with private investors, particularly short term traders, is growing rapidly for a number of reasons:

1. You can trade on margin

   This means that your broker effectively 'lends' you money to trade and consequently you don't have to have as much money in your account as you would if you were buying the shares themselves. Margin requirements are considered in more detail on the next page, but the key point is that margin allows you to leverage your capital to gain exposure to a larger parcel of shares than if you were actually buying and selling the shares themselves.

2. You can go short as easily as you can go long

   Shorting in the ordinary share market is not easy. With CFDs, however, you can go short as easily as you go long. If you think that a stock or index is going to fall in price, you open your contract by selling the CFDs, then close out with a purchase at a lower price, and profit from the difference.

3. You don't have to pay stamp duty

   The 0.5% stamp duty levied on share purchases brings about £4bn into the Exchequer every year. For frequent traders, who buy and sell shares at short intervals, the duty is an unwelcome extra cost. CFDs offer an escape. Since, with CFDs, you don't actually buy shares, you don't have to pay stamp duty.

4. Guaranteed stop losses

   One of the key advantages of CFDs over share trading is that some brokers offer guaranteed stop losses. This means that you know in advance what the worst losses you sustain will be. In fast-moving markets, that safety-net can be advantageous.

5. Extended hours

   Some CFDs have extended trading hours outside those of the underlying share market.

6. Range of markets

   Depending on your choice of broker, you will be able to trade CFDs not just on individual stocks but also on international shares, indices, currencies, sectors and a variety of other securities.

7. There is no fixed settlement date

   CFDs do not have a fixed settlement date. As an owner of CFDs, your position remains open until you choose to close it, which gives you more control than you would have with, say, a spread bet (where the contract usually has a predetermined expiry date).

8. Settlement is instant

   On the closure of a trade, settlement into your account is instantaneous. There are no share certificates to be dealt with, no complicated paper trails, no T+3 times to be considered, and you don't have to wait for your money.

However, it is important to be aware that, unlike shares, with CFDs you are potentially liable for far more than the amount you have paid on margin. It is important to consider the use of stop losses to limit the money you could lose.

1. What are CFDs? 2. The benefits of CFDs 3. Initial margin 4. Variation margin 5. Commission costs 6. Interest payments 7. Dividends 8. Example of a long and short trade 9. Comparison of CFDs to share investing 10. Comparison of CFD trading to spread betting 11. Types of order 12. Stop losses 13. Strategies: Pairs trading 14. Strategies: Hedging an equity portfolio 15. Opening an account with a broker 16. Conclusion

• Single Stock Futures: The Complete Guide