A CFD (Contract for Difference) is an arrangement between two investors to trade on the difference between the start price and finish price of a contract at the end of an agreed timescale without either party needing to buy the shares themselves. Although it does sound rather complicated it is not too bad at all.. Major hedge funds have been making use of Contracts for Difference in the UK stock market for just over ten years instead of regular share trading. CFDs have much in common with financial spread betting in that both of them are margined products so you can gear yourself up or actually take a decision that is a multiple of your available funds.
So if you take the margin on a firm youre interested in was 10%, establishing a position of £100,000 would really only require a deposit of £10,000. Any running profits you make can be used as margin to establish new positions but any running losses would have to be made good by reducing your position or providing additional funds.
While the stamp duty of 0.5% on all UK share purchases has in the opinion of some traders reduced the cost effectiveness of ‘day-trading’ traditional stocks and shares, both CFDs and spread betting are exempt and this has added to their appeal. CFDs are quite liable to capital gains tax whereas spread bets are tax free, but losses incurred from spread bets are gone for good while CFD losses can be offset against future profits for tax purposes. When you trade in CFDs, you purchase those contracts in almost the same way that youd buy shares. Let’s say you wished to invest on a thousand shares in a business – with CFD trading you would need to sell 1,000 units at eg 494p per share, whereas with spread betting you would just place a bet of £10 per point to get an equivalent return.
Most CFD providers admit you to post orders anywhere within the bid-offer spread whereas spread betting firms post their own two-way take it or leave it price exactly as a bookie would. With CFD you are the cost maker, which is why hedge funds tend to use CFDs rather than spread betting. With CFD you are the price maker, which is why hedge funds tend to use CFDs rather than spread betting. With CFDs the charges and commissions involved in a trade are not part of the spread, which is the case with financial spread betting. Because of this, the CFD spread quote will constantly be very close to the underlying price of the share or commodity that you are following. CFD’s also mimic almost every aspect of actually owning the underlying share or market, so if you hold a position long enough, you receive the benefit of any dividends being paid on the underlying shares.
CFDs and spread betting have particular features that will appeal to different trading styles and there is no one best instrument to use. Although they should not be regarded as substitutes for long term investment or saving, as more people seek to take control of their financial destiny, theres been a growing realisation that going short is a legitimate means of trading in market thats become increasingly difficult to profit from in a traditional sense.
