A Contract for Difference (or CFD) is a trade between two people where the difference between the opening and closing price is exchanged without owning the underlying share. A trader in CFDs will buy or sell a number of contracts (or Lots) in a chosen Market and when the trade is closed, the gain (or loss) will be the number of lots multiplied by the difference in price.
Let’s look at a share trading example first.
Say you believe that the price of BP shares which are currently trading at 500p, will rise. You could buy 1000 shares of BP requiring an investment of £5000 and if the share price rises to 550p you would make 50p per share. i.e £500 on 1000 shares. This £500 gain would be reduced by the stamp duty and any initial trade execution charges.
Alternatively you could place a CFD trade.
Let’s say you buy 1000 lots of a CFD contract in BP at 500.
This will require a margin deposit to support your trade. In the case of a FTSE 100 company this would be 5% of the value of the full share investment. Note that margin requirements vary dependent on the market you are trading. These requirements can be found on all trade tickets before you place your order.
Once the trade is opened our platform will monitor and display your profit and loss levels in real time for you.
If the price rises to 550 and you close the trade, your gain will be 1000 lots times 50p = £500.
Any profit or loss made from your CFD trading will be instantly realised in your account.
There are no trade execution charges as the fees are contained within the spread price and because you don’t own the underlying shares then you are not subject to stamp duty in the UK.
As you can see in the example, 5% of capital was required to make the same gains as share trading. This is known as a leveraged product. Note that if the price went against you and the level dropped 50 pts then you would have lost £500. The risks are higher with CFD trading than with other investment strategies.
CFD trading is not suited to everyone it requires discipline and the control to invest when the risk/ reward ratios are understood and managed. If you are an investor who does not want to monitor market data daily or is risk averse then you should looks at other alternatives to CFD Trading which may be less risky, then share trading may be the better investment.
If you are new to CFD trading or an experienced player then our platforms allow you to trade with confidence across global markets 24hrs a day, with a single simple to use, highly flexible, robust trading platform. If you are not sure you want to leap straight into trading with you own money now then read our other guides or open up a demo account and test it out in a risk free environment.
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