CFDs Primer

By Fouad Bajjali
Business Develoment Manager
IG Markets CFD & FX Trading


Introduction

Contracts for Difference (CFDs) have been around since the early 1990's when they were created in London and based on equity swaps.

The initial reasoning for this product was the benefit of trading on margin and being exempt of UK stamp duty and UK tax.

They were an important financial tool for hedge funds and institutions to hedge their exposure to stocks in a cost effective way.

Since then CFDs have had a meteoric increase in popularity due to the fact that they have been introduced throughout Europe, Asia and Australia, furthering the recognition of the benefits for clients to utilise CFDs as an investment tool.

The Financial Services Authority (FSA) currently estimates that CFD related activity accounts for 30% of daily equity trading on the London Stock Exchange.

What are the benefits?

There are several benefits for clients who choose CFDs over traditional broking methods. The most obvious of these is the fact that a client can hold the same market exposure to a particular product with a much lower initial investment.

For example, if you think the shares of SIA will rise, you can buy 5,000 shares as a CFD at the current market price of $16.00.

• Your investment costs $80,000.
• But if you use CFDs, only a 10% deposit is required on selected index stocks, so in this example $8,000.
• If the price rises to $16.50 and you decided to sell, your profit is $0.50 x 5,000 shares = $2,500 – to be credited into your account
• If the price falls to $15.70 and you decided to sell, your loss is $0.30 x 5,000 shares = $1,500 – to be debited from your account

To determine overall profit or loss you also have to take into account the commission and interest paid, and any dividends declared.

Additionally, with CFDs any client can benefit from a downturn in the market, as you are allowed to go short on any product, including equities. This clearly increases the client's dealing spectrum, as no matter how volatile the current market conditions, you can still aim for profits as a retail investor.

CFDs are available on a whole array of products such as:

• Shares
• Currency (FX)
• Commodities
• Indices
• Options

Costs when dealing CFDs

When dealing share CFDs, clients will generally be subject to commission and funding costs. The latter will most commonly be calculated by utilising a one-month interbank rate, plus or minus the brokers percentage charge. All non-share products will generally be spread based, in other words – no commission is applicable as it will already be factored into the price, or the spread between the buy and sell prices.

Margin Calls

When trading CFDs it is possible that you may have to further fund your account if your open positions are moving against you; nonetheless, the more reputable CFD providers will permit the use of "guaranteed stops". A guaranteed stop is an absolute risk limitation device, allowing clients to have full knowledge of their maximum potential loss.

When you place a guaranteed stop (or stop loss) on your CFD, you set the exit price for your trade. Your position will be closed out at exactly your selected level should the market move against you, even if there is a very sharp overnight move.

When dealing CFDs, clients must be fully aware of their market exposure, and understand that losses can exceed initial investment.

Dealing Platforms

As discussed, CFDs have become increasingly popular with investors and for this reason the providers have expanded their products and platforms to meet the demand. Nowadays clients have the capability to trade using web-based platforms as well as their mobile phones or PDA's. This gives clients quick and easy access to manage their active portfolios practically 24 hours a day, 7 days a week.

CFDs are an ideal tool for investors who understand the risks of geared financial products. Commission rates are extremely competitive in comparison with classic Stockbrokers and are easily accessible via the Web or Mobile Dealing applications.

Disclaimer
This article is provided for information purposes and should not be regarded as financial product advice. The information does not take into account your specific objectives, financial situation or needs. Therefore, you should consider the information in light of your specific objectives, financial situation or needs before making any trading or investment decision.

IG Markets recommends you take independent financial advice before any decision whether to trade with IG Markets in the products we offer.

Please remember our products are geared and can result in losses that exceed your initial deposit. They may not be suitable for everyone, so please make sure that you fully understand the risks involved.

IG Markets (ACRA No. 53059261X) holds a capital markets service licence for dealing in securities, trading in futures contracts and leveraged foreign exchange. IG Markets is also licensed to trade commodity CFDs by The International Enterprise Singapore. IG Markets does not operate any securities or futures markets. IG Markets Ltd, #22-04 Chevron House, 30 Raffles Place, Singapore 048622

SIAS does not endorse or promote any financial products. You must seek advice from your financial advisor before investing.

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