FAQ

A CFD is a contract between a broker and a trader, regarding the price of an underlying stock. The CFD trader bets on the direction of a certain stock price and decides on the number of shares he would like to bet on. If the bet is correct, when the trader closes his bet the CFD broker will pay the difference between the opening price and the closing price, multiplied by the amount of shares in the contract. If the bet is incorrect, the trader will have to pay the broker the difference.

CFD brokers usually charge a commission between 0.25% and 5% of the contract value on every trade made. This means that a commission is paid when a position is opened and again when it is closed. These commissions are usually less than the commissions charged when actually buying shares stock, especially when stamp duty is considered.

The contract value is the total value of all the stocks that you are betting on. So if a trader bets on 1,000 shares of a stock worth 250p, then the contract value would be 250,000p. CFD trading is almost always done on margin, so usually only about 10% of the contract value is required from the trader.

Making a purchase on margin means that the seller is lending a certain percentage of the money required to the buyer. When purchasing a CFD, the trader will pay for about 10% of the stock he is trading. If the markets move in his favour, he will earn the entire profit and if he loses he will owe the losses of the entire contract.

An interest charge is something that people going long on a stock will have to pay for borrowing money. Because CFDs are made on margin the broker is lending the trader money, therefore the broker will charge the trader interest on this loan. On the other hand, if the CFD trader takes a short CFD position, then the broker will credit their account with the interest.

Interest is calculated and charged/credited daily, by taking the predetermined annual interest rate and dividing it by 365.

Dividend charges or credits are very similar to interest charges, because they are used to ensure that CFDs mirror the value of their underlying stocks. If a trader holds a long CFD on a stock during a dividend payment period, they will receive payment for that dividend on the ex-dividend date, from the brokerage company.

One of the main advantages of CFDs is that they decrease transaction costs, while mirroring the share price. CFDs have less transaction costs because stamp duty does not have to be paid on any trades. In addition they take into account dividends and interest rates, so in effect the CFD trader earns all the benefits of actually purchasing the stock, whilst not having to feel the burden of stamp duty taxes.

There is no minimum contract value requirement once you have set up an account at a CFD brokerage. However, there is a £10,000 minimum deposit required to open one of these accounts.

CFD accounts are often used by day traders to allow them to make dozens of trades an hour, while keeping their transactions costs low by not paying stamp duty. In order to accommodate these customers, there is no limit to the amount of trades that CFD traders make.

Because of the fact that CFDs are traded on margin, and therefore traders are charged interest on their bets, they are not a profitable on a long term basis. If a long term investment is desired, then traditional investing is much cheaper because the 0.5% stamp duty on the purchase will be less than the interest expenses incurred by holding a CFD for a long period.

The most important function that reduces the risk of a CFD is a stop loss function. This will ensure that once a pre-determined loss is reached, the trade will be closed and prevent any further loss from taking place. Other ways to limit risk are to bet on a smaller margin, such as 50% or 60%, and to make smaller bets.

This is a common confusion that is made between CFDs and options. If an option is purchased, and is out of the money, it does not have to be exercised. If a CFD is losing, it must be paid off whenever it is closed to fulfil the contract. This makes it very important for traders to determine at what point they want to close their bet and cut their losses.

There is an ever growing list of markets that CFD companies are offering. Currently most large cap stocks are available, as well as many indexes including the DAX 30, the FTSE 100, the NASDAQ, the NIKKEI, the DOW, the NYSE 100, and the S&P 500.

CFDs will mirror the complete value of the underlying share, but the trader will have absolutely no obligations relating to these shares. Dissimilar to options and warrants, it is never necessary to purchase any shares in order to close a position in a CFD.

Many CFD brokerages have begun to allow after-market trading, to suit their private investor clients who prefer to do their trading after work. This function, along with the automatic sell and guaranteed stop loss functions, makes it possible for investors to actively manage their CFD accounts.

This stands for National Trading Requirement. It is the amount of deposit required for the trader to start a transaction.

Find out everything you need to know about CFDs through our Online Tutorials