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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.