My Personal Finance Blog

What Are CFDs?

CFD (Contracts for Difference) trading is a method of investing that allows you to trade on a range of financial markets, such as indices, including the FTSE 100, Dow Jones etc., shares, forex, commodities or bonds, without owning the actual financial instruments traded in these markets.

A CFD is a financial derivative product. In equities CFD trading, it is an agreement that allows you to exchange the value differential of a share between the opening and closing time of the contract.

Going Long or Short

CFDs allow you to go long or short. Going long is a way of saying ‘buying’, while going short refers to selling a market. For example, if you believe that the underlying price of a market will rise, you can buy; if you believe prices will fall, you can sell. Going short, therefore, allows you to potentially make profit (or loss) from falling market prices.

The ability to go long or short using CFDsmakes these derivatives a flexible financial product; profits/losses can be made whether the market rises or falls.

Leverage

CFDs are a leveraged product. When you buy company shares, for example, you are required to pay the total value of the shares, plus, depending on your share trading platform, stockbrokers’ fees, commissions and stamp duty. CFDs, on the other hand, allow you to place a deposit that commands a potentially larger financial position.

Depositing a fraction of your total trade value still gives you full exposure and can result in enhanced financial gains or losses. The typical profit (or loss), after all, of your CFD trade is the total value realised once you close your CFD trade minus any broker’s commissions.

Like spread betting there is no stamp duty* on CFD trades. However because Contracts for Difference and spread betting are both leveraged forms of investment, they carry high levels of risk and it is possible to incur losses that are in excess of your initial investment.

If you are investing with Contracts for Difference or financial spread betting, you should always speculate with funds you can afford to lose; always make sure that you understand the risks involved when trading with these investment products. Like the warnings tell you, it is important to be aware that these products may not be suitable for all kinds of investor and, where you think it is necessary, obtain impartial trading guidance.

Managing Risks

Leverage can lead to both enhanced profits and losses, depending on the movement of the market and your trading decisions. Leverage is one of the main attractions of CFDs for many traders. Note though that you can limit your potential losses, before you sustain them, by using a number of risk management tools.

A commonly used risk tool is a ‘guaranteed stop loss’ order. A guaranteed stop loss order will automatically close a CFD trade once it passes a level in the underlying market that you set. Therefore if a market moves against you your trade will be closed and your losses limited.

* According to present United Kingdom and Irish tax law. This might change or differ subject to your personal situation.

The game played by politicians is to take an idea from their own agenda and then frame it in a way that sells it to the other side. When the politicians meet in the middle, bipartisan solutions to problems emerge. This reflects the fact there is no monopoly on good ideas, only simple good solutions to difficult problems. In the healthcare debate, one of the solutions proposed by the GOP was to allow people to buy their insurance across state lines. This sounds a good idea. As the law stands, every state regulates the sale of insurance within its own borders. This limits the size of the market. If insurers had to compete with each other on a regional or national level, the premium rates would fall and every citizen would get a better deal. Well, let’s look a little more closely at how it would actually work.

At present, every state has a Department of Insurance to regulate the insurance companies licensed to sell policies. This is a reasonably effective system for consumer protection. But if regional or national insurers could sell policies into many states, it would break the regulatory system. It would no longer be local supervision of local companies. Insurers would decide where to establish and would, of course, choose the states which had the weakest consumer protection regulations, i.e. where they could make the most profit. Think banks and finance companies. These companies broke the US economy and produced the recession because their sales of subprime mortgages and associated derivatives were unregulated. Now apply the same thing to interstate insurance. As a final thought on this issue, remember all US states have different laws and one state cannot enforce another’s laws. That is sovereignty for you. So the state where an insurer is based cannot protect consumers under another state’s laws.

Secondly, opening the market across state lines allows insurers to cherry pick the best people to insure. Without regulations to limit the right to discriminate against people for pre-existing conditions and to increase premiums as people get older and fall ill more often, insurers will just take their profit from all the healthy people and forget about the rest. Thus, instead of increasing consumer choice, it would have the reverse effect. Most insurance companies would close their branches in individual states. Those that remained would keep all the aging and less healthy people. As their claims rise, the companies will make a loss and close. Without a law to mandate regional or national companies to offer some health coverage, it is likely the number of uninsured people would rise.

When you add all this up, it is a good thing the GOP’s proposal was rejected. Health insurance plans are complicated enough without having to change a whole mass of federal and state laws to allow interstate sales. This is not to say that consumers might benefit if there was more competition in the insurance market generally. With a real free market, properly regulated, consumers would get a better deal both in the terms of coverage and in the premium rates they pay. As it is, you must get multiple health insurance quotes. Anticipating their profits will take a hit following this reform, insurers have been raising their premium rates. You must shop around to find the most affordable policy.

Investing in the right sectors at the right time is the prerequisite to getting the best return on the investments that you make during your working life. As you all would very well know from the investor education initiatives of the business press, investments in the stock markets have consistently fetched good returns on the money that you put in. But in this mode of investment the opportunity to pull out the profits do not come very often. This is why you must invest in market derivatives like the CFDs as they give you the chance to make frequent profits from your long or short positions.

Let us first gain an in depth understanding on the contracts for difference or CFDs as they are popularly known in the stock market circles. When you get into CFD trading you are actually using the technique of hedging to minimize the potential risks in stock trades. There is an opportunity for you to spread you risk over a period of time while reserving the opportunity to exit with minimal losses should your call go wrong. You do not have to be tied in with the call that you are making for a long period of time. More importantly, you would be in full control of all investment decisions.

The biggest advantage of using the contracts for difference is that you would not have to put in the entire money for your call upfront. Of course the CFD in this case would incur some charges but these are negligible when compared to the huge profits that you could get by trading in these derivatives.

The versatility of being able to use both the long and short options while going in for CFD trading is what makes most of the established market players choose CFDs as their preferred mode of investment in the stock market in the country. In other words, these derivatives provide you the equal opportunity to enter the market at any time irrespective of whether the share prices are moving up or down.

The stock brokers and broking houses have also recognized the importance of providing the contracts for difference based services to their clients and this is the reason why many of the leading brokers in the country have worked to keep the costs minimal in the CFD trades. The shorter the period of the contract, the greater the profits that you can expect to take home. This is the reason why many investors are being educated by their brokers on the attractiveness of investing in these stock market derivatives.

Once you start investing in CFD trading, you should make some time for trending the market and the stock on a daily basis. Some of the brokers would provide you with specific tools to track your CFDs. You can use these to get to know the exact position of your investments. As with other investment platforms, a good understanding of the economic sector and the company management that you are considering an investment in is a prerequisite for successful investment in the contracts for difference trades.

“CFD trading won`t be appropriate for everybody so please ensure you understand the risks involved.” It is for legal purposes.