CFD trading – the new trading tool for the speculator on the move

CFD trading - the new trading tool for the speculator on the move

CFDs stand for Contracts for Difference, a relatively new way to trade the markets quickly and conveniently for the private trader and investor. It has become the modern mans way of trading the financial markets, be it speculating in stocks, currencies, stock indices or even commodities such as oil and gold.

What does it mean to trade a CFD?

Trading CFDs means that you are speculating on the direction of a financial instrument like a stock, or an index. The definition of a CFD is:

"An agreement between a broker and a client to exchange the monetary difference between the opening price and the closing price of the instrument traded".

In other words, CFDs work very much like traditional trading but have certain advantages which make them a more attractive tool for the active investor.

CFDs gives you access to financial markets all over the world

CFDs are traded on a small margin(10% or less)

CFDs give you access to global markets 24 hours a day

CFDs will allow you to go "short" any instrument

CFDs can be traded in currencies, commodities, indices and stocks

CFDs are extremely easy to use

CFDs will pay dividends in stocks

CFD accounts are held in currency of your choice

CFD trading is a tool for the active traders and speculators who want to a global reach in their portfolio. The trades can be executed on the road via a mobile, or on a trading platform.

CFDs are a one-stop solution for trading many different markets under one platform, wherever you may be, whenever you want, in whatever product you wish.

Trading markets on Margin

Margin is another word for leverage. It means that you can trade different markets without paying the full value of the transaction. Instead you will pay a deposit in your account, known as the margin requirement.

CFDs have a very small margin. You can trade different a CFD on as little as 2% margin. Generally stocks have 10% margin. Stock Indices such as the FTSE 100 will be on 5% margin while currencies and commodities can have as little as 2% margin.

There are two kinds of margins though. The initial margin is the capital requirements needed on the trading account to execute the trade in the first place. However, the variation margin requires that any open loss will be funded 100%.

Example

Vodafone is trading at £1.34 and you purchase 1000 CFDs (shares). The cost will be 1000*£1.34 = 1340. However, you are only required to deposit 10% of the transaction value on your account, which means you have to have at least £134 on your account to execute this particular trade.

However, Vodafone moves against you and is trading at £1.30. Now you are losing 4 pence per CFD (share) and you are losing £40. The variation margin states that you need to cover your loss in full on your account, so in this example you will need an extra £40 on your account, above and beyond the £130 you deposited for your initial margin.

Conversely any open trades yielding a profit will require less money in margin, by the amount of the open profit.

CFD Trading Platform

Most CFD providers like City Index supply a state-of-the-art solution for the on-line trader as well as the busy investor. What you should look for is the following specifications:

On-line instant execution of orders on market prices

On-line stop and limit orders including guaranteed stop-losses

On-line real-time and historical charting database

Stock scanner for both fundamental and technical criteria

Fundamental Research Centre
Example:

Vodafone is traded at 136.75-137 by City Index CFD brokers. You decide to buy 10,000 CFDs at 137.

The value of your transaction is £13,700, but you need to remember that you only put down a small percentage of the value of your transaction as collateral. In this case it is 10%.

Over the course of the next week Vodafone is steadily rising in value. You decide to take your profits at 150 and you close your position.

Your profit is £1300, but there will be some commission cost involved. When you are trading CFDs there are two kinds of costs:

Cost of the transaction - commissions

Cost of financing the position overnight - interest rate charge

Commission for UK equities is as cheap as 0.2% of the value of your transaction while European and US shares are often charged 0.3%.

Generally CFDs brokers do not charge to trade commodities, currencies and indices. The reason is not because of their altruistic nature, but rather that a spread in the price is factored in.

Commission and Financing

Commission are charged when you enter and when you exit the trade. If you exit parts of your trade you will be charge on the closing value of the part you are closing.

When you are buying a CFD product you will pay nightly interest. However, when you are shorting a CFD product, you will receive the nightly interest.

The interest rate used depends on what currency your CFD product is traded in. For example when you trade UK stocks, you will be using the interest rate in the UK. The interest is paid or charged from your account on a nightly basis.

Conclusion

The CFD market is growing exponentially. Today as much as 30% of the volume on the London Stock Exchange is attributed to CFD trading. This was only 10% 5 years ago. Many financial institutions use CFDs for their shorter-term trading. CFDs allows the user the flexibility of instant execution as well as the ability to hedge their underlying shares by selling "short" the equivalent CFD. And of course it allows the nifty speculator easy access to the worlds financial markets from just one trading platform.