What are CFDs?
Let's face it. Traditional share trading has its disadvantages. With no leverage and having to pay additional fees such as stamp duty*, a lot of your money gets tied up unnecessarily.
There is a more cost-effective way to speculate on stocks and other financial instruments. CFDs are flexible products that allow you to take a view on thousands of markets from all over the world, without many of the costs associated with ownership
CFD stands for contract for difference. Essentially, a CFD is an agreement with a provider (such as Tradefair) to exchange the difference between the prices of an underlying financial instrument at the point when you entered the trade and at the point when you exited the trade. Rather than buying and selling that physical market, the CFD mirrors the price and - when the CFD is closed - it is settled in cash.
One of the benefits of CFDs is that they can be used to take advantage of both rising and falling markets. Because trading CFDs does not require ownership of the asset, selling is as easy as buying.
You can also leverage your CFD trades, which means that you can put up a small margin to open a much larger position. What's more, CFDs have fewer costs and restrictions than other financial products, and you don't incur stamp duty. However, please remember that leverage can work for you and against you. Even though you only need a small margin, you may incur a loss larger than your margin.
Because CFDs are based on prices and nothing is actually exchanged, you can avoid the costs that come with physical ownership of an asset, such as having to pay stamp duty (under current UK legislation*) and account management fees. With less coming off of the top of each CFD, you can afford to make more trades and move in and out of the markets with relative ease.
CFDs can also be more tax efficient than other forms of trading. Depending on your circumstances, you can use any losses you incur through CFD trading to offset your Capital Gains Tax liabilities.* For more information on this, seek independent investment advice.
*Tax laws are subject to change at any time.
CFDs can be an effective way to hedge your portfolio. For example, if you are concerned that the stock market is due for a sell-off, you can protect your share portfolio by short selling CFDs. In this way, you can protect yourself without going through the expense and inconvenience of liquidating your stock holdings.
Leverage - trade more with less
Leverage allows you to trade larger positions with less money. With a leverage of 100:1, you will receive £100 worth of market exposure for each pound that you invest. If we take our previous UK 100 example, for every CFD that you trade on the UK 100, you only need to cover 0.5% (200:1) as margin, so one CFD on the UK 100, at a price of 6,000, requires an initial margin of £30 (6,000 x 0.5%). This means that you can see a much higher profit gain in a shorter time period compared to other forms of trading. However, trading CFDs can also lead to deeper losses than you would without the use of leverage.**
**CFD trading involves high risks, with the potential for substantial losses and is not suitable for all persons. The high degree of leverage can work against you as well as for you. Past performance is not necessarily indicative of future results.