CFD Trading Guide

CFDs let you speculate on share price movements without having to buy shares. They are essentially an agreement between an investor and a provider to exchange the difference between the nominal value of the opening and the closing trades.

Like spread bets, CFDs are leveraged products – since you are not buying the share, you do not pay stamp duty, of course, tax laws can change. However, unlike spread bets CFDs are not regarded as bets. This means they attract Capital Gains Tax (CGT).

Initial margin

You can place a bet with a deposit known as initial margin.

Typically, the margin is calculated as a percentage of the overall value of the trade, usually between 1% and 10%. For example, if all your trades are eligible for a 5% margin, you can hold positions worth a total of £100,000 even when you deposit just £5,000.

Example of how to calculate margin

• You wish to buy 3,000 Share CFDs at 150p. The share CFD has a margin requirement of 5%
• 3,000 x 150p = £4,500 (this is the value of the position)
• £4,500 x 5% = £225
• To hold the position, you need to deposit £225 as initial margin
• The size of this margin depends on the type of asset you choose to bet on, but it usually works out around 10%.

Financing charges

If you hold a position overnight you'll pay financing charges.

Finance is calculated on 100% of the value of the position. If you buy (long), you'll pay interest to the provider. If you sell (short), you may receive interest, depending on whether your position is in profit or loss.

Example of how to calculate financing

Long position

• You buy 3,000 share CFDs of a particular UK stock at 150p and decide to hold the position overnight
• 3,000 x 150p = £4,500 (this is the value of your position)
• You are then charged interest at the official overnight LIBOR rate + 2.5%. This is multiplied by your total market exposure and divided by 365 days to give the daily overnight rate
• 5% + 2.5%* = 7.5%
• £4,500 x 7.5% = £337.50 / 365 = 92p
• Approximately 92p will be debited from your account for every night you hold the position open

Short position

• You sell 3,000 share CFDs of a UK stock at 150p and decide to hold the position overnight
• 3,000 x 150p = £4,500 (this is the value of your position)
• You are then credited an amount calculated by using the official LIBOR rate – 2.5%. This is multiplied by your total market exposure and divided by 365 to determine the daily overnight rate paid by you
• 5% - 2.5% = 2.5%
• £4,500 x 2.5% = £112.50 / 365 = 31p
• You will be paid approximately 31p for every night you hold the position open

There are a number of different ways:

1. Guaranteed stops
2. Limit orders
3. Stop loss orders
4. 'If-done' order
5. 'One cancels the other' (OCO) order

With a guaranteed stop-loss facility, your position is closed at a level pre-selected by you, despite dramatic market movements. Guaranteed stops carry a small premium.

Example of a guaranteed stop:

• You believe ABC Corporation will strengthen from its current level of 350.00, but you want to be sure of your maximum downside on the trade.
• You place a guaranteed stop order to sell 1,000 ABC Corporation CFDs at 320.00
• To do so, you will need to pay say, a premium of 2 points. The premium paid depends on the instrument you trade upon.
• So to buy, the price of ABC Corporation is 353.00. The market begins trading lower and deals at 321.00, then ‘gaps’. This means that the next available bid price you can sell at is 312.00
• In the case of a standard stop, the order would be executed at 312.00. However, because you have guaranteed your stop loss and despite the gap in the market, the provider will execute the order at 320.00.

A limit order lets you pre-determine either a price higher than the current price at which you wish to sell, or a level below at which you wish to buy. This means you can pre-define the level at which you want to sell to take a profit, or the level at which you want to buy below the current price of an instrument.

Example of a limit order

• You have bought a long position of 1,000 BP CFDs at an opening price of 530.00
• You believe BP will strengthen to 550.000
• You therefore place a limit order to sell 1,000 BP CFDs at 550.00

Limits can also be used to open positions.

You don't have to set up limits and stops with every trade you do. However, as a beginner, we recommend you use them.

Stop loss orders can be used to limit your trading risk and are an essential part of disciplined trading. Using stops means you are automatically taken out of a position if the market moves against you, which limits your loss.

Stop losses can also be used to lock in profit. If the market moves in your favour, you can move your stop order with the prevailing price, which locks in profit if the market suddenly moves against you.

Example of a stop loss order

You have placed a bet (buy) at £10 per point on XYZ at an opening price of 150p. You believe that XYZ price will strengthen. However, you want to limit any potential loss and place a stop order to sell £10 per point at 130p. This limits your loss should XYZ fall to 130p or below.

An 'if-done' order is a combination of two orders and can be used if you are unable to continually monitor the market but want to participate in market movements in your favour and/or exit a move against you.

Example of an 'If-done' order

• ABC is trading 1200.00 and you wish to buy if the price falls to 1190.00 but exit if the price continues to fall to 1180.00.
• You would place a limit order to buy ABC at 1190.00 and a stop loss order to sell at 1180.00.
• The stop loss order is only activated once the limit order is filled – hence 'if-done'.

A one cancels the other (OCO) order offers a number of advantages for those wishing to get in and out of the market without having to watch it constantly. It is the combination of both a 'link' and a 'stop' order and can be used to take a profit if the market moved in your favour or to limit losses if the market moves against you. For example:

A OCO is the combination of both a limit and a stop. It can be used to take a profit if the market moves in your favour or to limit loses if the market moves against you.

Example of na OCO

Contracts for Difference or CFDs were developed to manage investment risk but can also be used to accelerate your investment performance.

CFDs are leveraged products which mean they carry a higher level of risk to your capital than normal stock market investments, like traditional share dealing.

CFDs let you speculate on share price movements without actually buying the share.

Essentially it is an agreement between an investor and a provider to exchange the difference between the opening and closing price of the contract.

So if the share increases in value, you will receive the value of that gain. However, if the share falls in value, you will lose an amount equal to that drop.

CFDs give you access to trade a wide range of global financial markets not normally available to retail investors – such as commodities, agriculture, energy, metals for example silver, gold.

You can also trade in Foreign Exchange, sectors, indices and equities, to name just a few.

Whilst CFD trading isn’t for everyone, for those who understand the risks and are comfortable investing, there are a number of advantages:

• Hedging
• Cash extraction
• Speculation
• Short selling
• Tax advantages

With this type of investment you are predicting how the market, a share or commodity will perform. You are speculating on whether a price will go up or down.

If you prediction is right, you can make a profit - even if the market is falling.

Since you are not buying the share, you do not pay stamp duty, but, of course, tax laws can change. Remember, you do have to pay Capital Gains Tax on any profit you make.

Financial markets fluctuate throughout the day. These price movements are determined by supply and demand. At times these movements can be exaggerated due to uncertainty within the markets which in turn creates a higher potential risk for CFDs.

With CFD trading there is a risk you could potentially lose more than your initial investment – so you should only invest what you can afford to lose.

However, you can hold a Fixed Risk Account where any your loss would be limited to the funds in that account.

Find out more about CFDs by visiting the Learning & Research pages on natweststockbrokers.com