Cfd Workings And Trading ExampleBy Janice Bollinger | 12 March 2010, 09:29 BST
Although lacking the tax benefits of spread betting, CFDs are still a worthy instrument. You put down a fraction of money compared to trading ordinary shares in the same company. Effectively you put a deposit of between 5% and 15% for equities but get to trade the full value. For example, if you bought £10,000 of Punch Taverns (PUB) shares directly and the price moved by £500, you would make 5% profit (or loss). If you ran a CFD on the same company, where it has a 10% deposit margin for example, your trade would cost £1,000 but the value would still move by £500, giving you 50% profit (or loss).
CFD trades incur a financing charge which is typically 2.5% above Libor (the rate at which banks borrow from each other). This is to cover the cost of providers effectively lending you the stock not covered by your deposit. As CFDs are a margin product, profit and loss is calculated on a daily basis. If the trade is not working in your favour, there is a risk the provider may request more money (a margin call) to maintain your position. CFDs are eligible for inclusion in a Sipp but only a few providers offer this facility.
There are two types of providers 'market makers' and 'direct market access' and there are pros and cons for both. Markets Makers are generally cheaper to trade but they control the price, Direct market are more expensive but there is a corresponding trade on the exchange so the prices are whatever the market's quote is.
Please be aware that CFDs are margin traded product and can be a double edged sword. When the going is good it is very, very good, when the going is bad- it's deadly! Stop-losses are an important part of your strategy (learned that one the hard way!) because a gap down can wipe you. Another benefit though is the ability to short when the market is dropping so you can trade both ways.
If you aren't already trading in the normal stock market I would really not try CFDs.
About the Author
My name is Janice Bollinger. I have been trading CFDs medium for 5 years now. I am profitable currently, but working on making this consistent, as well as attempting to build my capital to a level where the profits actually mean something.
Article Source: Cfd Workings And Trading Example