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CFD Trading

What is CFD trading?

Answer ...

Contract for Difference (CFD) trading allows you to trade a huge range of markets without physically purchasing the underlying instrument. As with spread betting and options trading, it gives investors the ability to make money in both a rising and falling market as you can enter both long and short positions.

CFD’s also give you the ability to take highly leveraged positions, typical ranging from 1 to 30 times your initial capital.

When you trade a CFD, your profit or loss is calculated using your opening contract value and the closing contract value. The degree to which you are correct and your position size dictates how much you make or lose.

To help you understand CFD trading, it’s useful to work through an example:

In order to place a long trade (if you think a security will rise in value), you need to buy the CFD (as opposed to sell if you thought prices were going to fall).

Lets say you thought ABC Ltd (trading at 150 – 150.5) was going to rise and you therefore purchased 10,000 shares as a CFD at 150.5. The total value of the contract is £15,050 but typically you would only need to put down an initial margin of 10% (£1,505).

The commission your broker is charging on this trade is 20% and therefore equates to £30.10 (£15,050 x .20%). You don’t need to worry about stamp duty charges when trading CFDs.

A week later the stock price rises to 155 – 155.5 and you decide to close the position by selling 10,000 ABC CFDs at 155. The commission on this sell trade is £31 (£15,500 x .20%)

We can now calculate overall profit taking into account the commission charges.

You’ll note that we have also included a financing charge. When you
enter into a long position, if you hold a position overnight it
will be subject to a financing charge.

Short CFD positions are paid a financing charge. The rate of interest
charged or paid will vary according to the broker that you use but it’ll
usually be around two percent above or below the current London Inter
Bank Offered Rate.

  So, to the final profit summary:

  Opening Level: 150.5p
  Closing Level: 155.0p
  Difference: 4.5p
  Profit (4.5p x 10,000) = £450
  Commission: £61.10
  Financing Charge (estimated): £12.50
   Overall Profit: £376.4

It is important to note that the investor could just have easily made these losses as opposed to gains.

IG Index Intro to CFD Trading

Trading Signals Resource: Alpha Forecast

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