What are CFDs?

CFD stands for "contract for difference", and the name is descriptive of what they are. They are contract between two parties who agreed to pay or receive the difference in price of a financial instrument between the start and the finish of the contract. The financial instrument may be a stock price, a commodity, or a foreign exchange rate.

How do I make money with CFDs?

If you can correctly decide if a stock or other security is going up or down in value, then you can trade the CFD for this action. Note that if you get it wrong, instead of profiting you will lose the difference you contracted for.

If I gain when stock prices move, why should I trade CFDs instead of just trading stocks?

There are two very good reasons to use the CFDs. Firstly, CFDs are traded with leverage which means that you only need 5% to 10% of the stock value to enter the trade. Secondly, a CFD trading account will give you access to many different types of financial instruments, which would normally require separate accounts to trade.

What types of financial instruments can I trade on?

This will depend on your broker, but will usually include stocks and shares, market indices, commodities, foreign exchange, precious metals, and even market sectors. CFDs even allow you to trade from the same account in the markets of different countries.

If CFDs are so great, why would I ever trade in any other way?

CFDs are a short term trading tool. Because of the leverage you enjoy, there is a daily charge for interest on the value that you do not have to pay. If you want to buy and hold shares for the long-term, then you should not consider using CFDs.

Tell me what margin means?

Trading on margin that means that you are effectively borrowing money from your broker. You do not have to deposit the full value of the shares that you want to trade. This has the advantage that you can buy into a greater number of shares for your money, and potentially achieve greater gains. It has the disadvantage that you must make an interest payment regularly to your account.

How long can I hold CFDs?

Unlike futures, they is no expiration date for a CFD. However, you will be charged interest every day on the margin you are using, so you would not use a CFD for a long-term investment.

What are the trading costs with CFDs?

With some markets, the costs are included in the "spread", that is the difference between the buying and selling prices you are quoted. This is similar to the way you trade Forex. In other markets, you will be charged a commission based on the contract value for every transaction, which includes opening the position and closing the position.

Are there any other costs for trading CFDs?

Yes, there is a cost for using the leverage that CFDs enjoy. You will be charged interest daily for the margin, which is effectively the broker lending you money. This applies if you go long, that is you expect the financial instrument to increase in value. However, if you expect it to fall in value and go short, your account will be credited with interest. If you are trading CFDs in equities, then you may also be charged for the dividend, or receive a dividend if you are in a long position.

So CFDs are similar to owning stocks on margin?

Not really. You never own the stocks so have no voting rights. All you are doing is "betting" on the change in value. This has the advantage for the UK market that you do not pay stamp duty on the transaction, as you would if you dealt with the actual shares.

I sold the CFD I traded for a profit after two weeks. Why did my broker make me put more money in my account after the first week?

It sounds like you had a margin call from your broker. CFD contracts are valued every day, and the amount in your account is updated. If the value goes down, then the broker may ask you for more money even though you have not sold the CFD. On the other hand, if the value goes up there will be more money in your account even in the middle of the trade. This is called "mark to market".

Can I lose my whole account?

Yes, if your trade does not work you can lose more than your whole initial investment. Your broker will require you to make this good. It is important to understand what you are doing, and set reasonable stoploss orders to protect yourself from large moves in the market.

Are there any liquidity problems trading CFDs?

Generally no. The liquidity of the CFD is usually about the same as the underlying financial instrument. For example, the liquidity of an equity CFD would be similar to that of the underlying stock.

What is DMA?

DMA stands for direct market access. If available from your broker, it is preferable as it allows you to trade directly with the market pricing, rather than the prices being filtered through and perhaps adjusted by your broker.

I'm worried about losing too much money, can I get a guarantee on my stoploss order?

First, you are right in thinking that an ordinary stoploss order may not be fulfilled at the price you asked for. This can happen if the market moves quickly, or if there is a gap at the opening of the market. Many brokers can provide a guaranteed stop which will be fulfilled at the stated price, and there is usually a charge for this facility. Guaranteed stops may not be available on all indices or shares.

CFDs sound like options - is there any difference?

There is a big difference. If the option is in a losing position, then you do not have to "exercise" it, or settle it. As the name implies, buying an option allows you to optionally trade the underlying for a profit. If the underlying goes in the wrong direction, you can let the option expire worthless.

A CFD is a contract, and it must be fulfilled. This means that you must settle the value in cash, even if it goes against you. The difference is that you can wait for the price to turn around, and choose when to close the contract, which may help. However, this may not be worthwhile, as you will need to satisfy margin calls from your broker, and pay daily interest while the trade is open.