So how are the prices of CFDs worked out? As indicated before, the great advantage of trading CFDs is the leverage that you receive for your investment. The amount of leverage will depend on your relationship with your broker, and may typically be 10 to 1.

Effectively what you do is provide a deposit of 10% of the security value in order to take a position in the CFD. This deposit is sometimes referred to as the initial margin, and may range from 5% to 20%, depending on your broker and sometimes on which type of CFD you are buying.

It is important to note that you never own any shares, or any rights to the shares, when you trade CFDs. This is an important distinction from trading futures or options. This is also what makes CFDs a form of betting rather than investing, and saves the UK stamp duty.

Your CFD broker may hedge your position by investing in the shares. Most equity CFD providers use some system such as this to avoid risk. This means that you and your broker are not actually on different sides in the transaction. Any profit due to you will be received by your broker because of his share holding. In this way, the broker will not be exposed to losses, and can continue operating in a steady manner without having to guess the market.

When using this sort of system, you may be wondering how the broker makes any money. This brings us to the other costs of trading CFDs. Your broker will be charging a commission for each transaction that you make, and this is a straight profit. He will also be making money on a daily basis with a financing or interest charge. Of course, if he buys the shares to hedge your trade, he is tying up his working capital so the interest charge is a reasonable reward.

For a commission you should expect to pay anything up to a quarter percent of the contract value for each dealing. When you buy then sell a CFD you execute two trades, so the commission charges might be a total of half percent.

An alternative pricing structure adopted by some CFD providers is to charge a fixed commission. In this case the provider will frequently make up his profit by providing a wider spread between the bid and offer prices quoted to you. Depending on the size of your trade, you may find either system will work out better for you.

There will also be daily charges while you hold your position in the CFDs. These might work out to an interest rate of 6% to 8% per year, which comes out to about .02% per day, and are effectively interest payments for the money that you did not have to pay to take a full position in the shares. If you buy and sell a CFD on the same day you will not incur any interest charges.

Just as with futures, if there is a dividend payment due while the position is open, there will be an adjustment on your account. If you are long in the shares, you will receive a credit, and if you are short then there will be a debit to your account for the amount of the declared dividend.

If you are unhappy with the pricing available from your CFD provider, and particularly with the spread between the bid and offer prices presented, you may also find a broker who offers direct access to the market through a level II screen, in a similar way to when you trade stocks. This shows you all the activity and pending orders, which gives much greater transparency to the transactions.

The pricing explained above is applicable to individual securities, and when indexes are traded the system works slightly differently. Index CFDs are normally priced according to the underlying index and usually do not have a commission. The broker achieves his profits from the spread between bid and ask prices, which may be in the region of 3 to 6 points.

An alternative method of pricing Index CFDs is to base the price on the futures market, with the futures price adjusted to a fair value. Note that futures pricing is affected by other factors that do not apply to CFDs, such as the basis risk and variation in liquidity when approaching the expiring date.

As you can trade on many of the world indices, including the FTSE 100, Dax, and CAC 40 in Europe, the NASDAQ, Dow Jones, and S&P in the USA, and the Nikkei and Hang Seng Index, which include many different currencies, you should note that CFD prices are always quoted in terms of the base currency of the index. For instance the FTSE 100 price would be in sterling, pounds and pence, whereas the Dow Jones index would be traded in dollars and cents.

The aim is for there to be a transparent pricing arrangement, maintaining the trust between the CFD provider and the investor. The pricing structure allows for the investor to easily determine the costs and prices he is incurring, and allow for these in his trading strategy. Many CFD brokers will give you Direct Market Access, which means that the prices you are quoted are those which are being made by the market makers.