CFD's - Contract for Difference
CFD stands for Contract for Difference. A CFD is a type of derivative: the price of a CFD is derived from the value of some other asset. Often with CFDs it is based on the price of a share, but it can relate to effectively any financial instrument.
Rather than trade or exchange the asset itself, a CFD is a deal whereby two parties agree to exchange money according to the change in value of the underlying asset between the point at which the deal is opened and when it is closed. One party will be a buyer (of the value of the asset), and one will be a seller. The buyer will make money (from the seller) if the asset value increases and will lose money (to the seller) if it decreases. Conversely, the seller will lose money as the price of the asset rises and make money as it falls. Put simply, therefore, CFDs are a means to gain exposure to the change in value of a financial instrument without actually being in possession of that instrument. When dealing CFDs with us, we act as a CFD provider, meaning that when you choose to place a deal, we will take the other side of the transaction. You choose whether you are a buying or selling, and this defines us as being either the seller or the buyer in the contract.
Trade example: buying British Telecom
When trading shares using CFDs, the procedure and terminology are all very similar to normal share dealing (and in many cases are exactly the same, in fact).
BT is trading on the London Stock Exchange at 297.25/297.5p. Having watched the stock consistently fall in price over the last few months, you feel that the stock is undervalued and a bounce in the last couple of days makes you think that now might be the time to take an exposure.You decide to buy 5,000 shares as a CFD with us. This means that rather than physically taking ownership of the shares, you are instead opening a contract with us that gives you the same financial exposure as if you had gone out and actually purchased the same number of shares.The price that we quote for shares is always the same as the price that is trading on the stock exchange. You therefore open your deal at 297.5p, the offer price of the shares.Just as with a regular share transaction, we charge a commission.
Margin
A fundamental difference between trading a CFD and physically buying and selling shares in the conventional manner is that when trading a CFD you only need initially deposit a small portion of the value of the stock that you are commanding. This is known as margin The amount of margin required varies according to the liquidity and volatility of the underlying instrument. For UK shares the margin requirements begin from as low as 5% of the underlying value, but can be larger, depending on which share you are dealing. Only having to put down a fraction of the value of the stock that you are commanding obviously makes trading easier and more convenient. It means that you do not have to tie up as much of your funds with a trade as would normally be the case.Should the share price move adversely, however, you need to be able to send further ongoing margin. BT is margined at 5%. You are dealing in 5000 shares at a price of 297.5p. This means that the underlying values of the shares in which you are dealing is 5000 x 297.5p = £14,875. The margin of 5% is therefore just £744.
