Introducing CFDs

If you're new to the world of investing, then it's very likely that you wouldn't have heard about CFDs before, and you probably wouldn't have considered trading with them. CFD stands for 'Contract for a Difference' and they're not particularly difficult products to get your head around in comparison to something like spread betting. With normal share dealing, you have to put down the exact amount of capital required by the share to make an investment, but on a CFD trade you can trade on leverage, which means you can put down a deposit, then a broker will provide you a short term loan to make up the difference. Take a look at CMC Markets if you would like to find out more about CFDs , and other trading options.

The 'contract' part of a CFD is between a buyer and a seller, stipulating that the seller will pay the buyer the difference between the current value of an asset and its value at contract time. If the value decreases, then the buyer pays the difference rather than the seller. Due to the buyer not actually owning the shares, as they are traded on margin, CFDs do not accrue broker fees, stamp duty or capital gains tax. However, a major drawback, and indeed a high risk factor, is that although you can get higher returns than traditional stock trading with less money, you may also suffer higher losses should the market turn against you.

Share Trading vs CFD Trading Explained
If you wished to buy 5,000 shares at £4 each, then on a normal trade you would need £20,000 to buy them in full. However, if you only had £5,000, you would only be able to buy 1,250 normal shares on a trade.

On a contract for a difference, you could use your £5,000 as a deposit on a Contract for a Difference on a 10% margin. You could then stand to make a much larger profit should the markets move with you. For instance, if shares rose by 5% you would stand to make a much larger gain:

Stocks: £5,000 initial investment rising by 5% = £5,250.
Profit = £250 minus trading fees and stamp duty.

CFDs: £5,000 deposit at 10% margin = £50,000.
£50,000 rising by 5% = £52,500.
Profit = £2,500 – no fees.

In this case the profit made by using a CFD is much higher than if you merely traded through shares. However, the risk is also much higher, as you could stand to lose more money if the market moved against you. A CFD is a useful tool for an investor who has money tied up in other assets and cannot find the desired amount to make a trade. It's also possible to short a stock on a CFD too – which is to speculate on the value of a stock or index decreasing in value.