A CFD is a contract on an underlying asset (for example, a share, commodity or currency) to pay or receive the difference between the opening price and the closing price of the asset.
In many ways, CFDs are very similar to the underlying assets on which they are based (e.g. shares). The difference is the leverage, which means movements are magnified.
CFDs: The Main Benefits and Features
* Tax treatment depends on your individual circumstances and may change.
In this example, an investor wishes to go long of (buy) £10,000 worth of Anglo-American shares, currently priced at £10 each. The investor believes Anglo-American’s share price is likely to rise. Accendo Markets offers Anglo-American on a 20% margin, so the investor only needs to invest £2000 (£10,000 x 20%) to open this position using CFDs.
| Opening Trade | ||
| CFD | Standard Shares | |
| Initial | £2000 | £10,000 |
| Total Value of Shares | £10,000 | £10,000 |
| Number of shares | 1,000 | 1,000 |
| Stamp Duty | 0 | £50 |
| Commission (0.25%) | £25 | £25 |
After a ten day holding period, the Anglo-American share price has risen to £11. The investor decides to close the position and realise a profit of £1 per share.
| Closing Trade(Gain) | ||
| CFD | Standard Shares | |
| Overnight Financing Costs* | £9.55 | 0 |
| Commission | £27.50 | £27.50 |
| Total Cost | £62 (£25+£9.55+£27.50) |
£102.50 (£25+£50+£27.50) |
| Closing Value of Shares | £11,000 | £11,000 |
| Total Profit | (£1000-£62) £938 |
£897.50 (£1000-£102.50) |
| % Return on Initial Outlay | 46.9% | 8.97% |
Alternatively, after a ten day holding period, the Anglo American share price could have fallen to £9. The investor decides to close the position and realise a loss. However, a stop-loss was placed on the position at £9.50, reducing the loss.
| Closing Trade(Loss) | ||
| CFD | Standard Shares | |
| Overnight Financing Costs* | £9.55 | 0 |
| Commission | £25 | £25 |
| Total Cost | £59.55 (£25+£9.55+£25) |
£100.00 (£25+£50+£25) |
| Closing Value of Shares | £9,500 | £9,500 |
| Total Loss | £559.55 (£500+£59.55) |
£600 |
*Overnight financing is based on LIBOR, and is therefore variable.
An investor believes the price of British Telecom (BT) is likely to fall, and therefore wishes to short (sell) £10,000 worth of BT shares, currently priced at £1 each. Shorting an asset is a ‘mirror image’ of buying it.
The investor is unable to short the BT shares with a traditional stockbroker, and is therefore unable to capitalise on a price drop using traditional shares.
| Opening Trade | ||
| CFD | Standard Shares | |
| Initial outlay | £2000 | – |
| Total Value of Shares | £10,000 | – |
| Number of shares | -10,000 | – |
| Stamp Duty | 0 | – |
| Commission (0.25%) | £25 | – |
As expected, the BT share price falls to 90p ten days after the position is opened. The investor decides to close the position and take a profit.
| Closing Trade | ||
| CFD | Standard Shares | |
| Overnight Financing Costs* | £7.55 | – |
| Commission | £25 | – |
| Total Cost | £57.55 | – |
| Closing Value of Shares | £9,000 | – |
| Total Profit | £942.45 | – |
| % Return on Initial Outlay | 47.1% | – |
*Overnight financing is based on LIBOR, and is therefore variable. When interest rates are low, negative overnight financing credit may occur. This means that you will pay a small amount of interest to hold a short position overnight.
This example is a profitable trade. As in the previous example, a losing trade would incur the equivalent loss.
As with all investments, there are risks involved in trading on the financial markets. We’ve tried to explain the risks as clearly as possible on this website, with the aid of examples. There are ways of mitigating your risk, such as stop losses. If you need further clarification, turn to the ‘risk warning’ section of this website or speak to an Accendo Markets representative. Of course, trading leveraged products like CFDs can be very rewarding and different trading strategies can be employed to great effect, but careful risk management is essential. Don’t forget that, although profits can be magnified using leverage, so can losses.
‘Cut your losses, run your profits’
A ‘stop-loss’ is a pre-set order to cut a position at a certain level, therefore restricting a loss. With a CFD account you have a choice between three types of stoploss; standard, trailing or guaranteed. However, you don’t have to use them. Some traders/investors have different trading strategies, and prefer not to.
In the scenario below, we use Vodafone (long);
Vodafone Entry Price 174p
………………………………………………………………….
Stop-Loss 167p
If you bought Vodafone at 174, and spotted a strong area of price support (i.e. did not believe that the price was likely to fall Vodafone Entry Price 174p Stop-Loss 167p below this level) at 167, you might set a standard stop-loss at this level. Therefore, if the price falls to 167 (and trades at your order size at this level for an appropriate length of time), the system would automatically close the position for you.