What are CFDs?
CFDs are a way of trading on global financial
instruments without having to buy or sell the underlying asset
directly. They provide the opportunity to make profits (or losses)
from price movements in a wide range of markets including equities,
indices and currencies.
Definition of a CFD
A CFD (Contract for Difference) is an agreement to exchange the
difference between the opening and closing value of a contract at
its close.
Rather than buying or selling the underlying
instrument on which your contract is based, you simply place a
trade with a CFD provider such as City Index. The price of your CFD
will then replicate the price of the underlying asset giving you a
profit (or a loss) as the price of the underlying moves.
CFDs can be used to speculate on upward or
downward price movements, making them a flexible alternative to
traditional trading.
How do CFDs work?
As with traditional share dealing, CFD prices
are quoted as a Bid (the price you can sell at) and an Offer (the
price you can buy at). Instead of buying a number of shares, with
CFD trading you buy a CFD based on the value of a certain amount of
the underlying asset.
Margins and CFDs
CFDs are traded on Margin, which means that to
open a position you need to deposit a fraction of the full value of
your trade. The amount depends on the market, and would typically
be around 10-20 per cent for an equity.
CFD trading therefore offers the possibility
of a much better return on your initial investment than paying for
the trade in full. Conversely, potential losses are also amplified
and if the price of the underlying asset goes the wrong way you
stand to make a larger proportionate loss than if you owned it
directly.
CFD example
If you bought $10,000 of shares directly and they rose by $500,
you would make a return of 5 per cent. If you opened a CFD on the
same shares, with a deposit (Margin) of 10 per cent, your outlay
would be $1,000 but you would still make $500 profit, providing a
return of 50 per cent. However, if the price moved against you the
CFD trade would result in a 50 per cent loss, compared to a 5 per
cent loss on the full value trade.