What are CFDs?
CFDs are investment instruments geared toward traders with some level of trading experience. It have some similarities and differences with respect to traditional shares investing but there are some clear advantages that should be considered by any trader looking for additional portfolio diversification. The CFD itself is a contract between two entities – the individual investor and the broker, outlining an agreement to settle the contract based on the difference between the opening and closing price. Dealing it will allow investors indirectly gain access to the price movements seen in the stocks, commodities, or currencies markets without actually taking possession of the physical asset. As a CFDs trader, you are looking to capitalize only on the price activity of the underlying asset, so gains can be made in both rising and falling markets.
What is Leverage?
One of the often-cited advantages of CFD trading is that it allows investors to “leverage” their positions, which essentially means that you have the opportunity to establish a position with an initial deposit, which is sometimes as small as 10 percent of the total CFD position. This gives traders the opportunity to control a much larger position than would be possible in traditional shares trading. This, in other words, translates into the potential to achieve much larger gains, as traders are entitled to capitalize on the moves generated in the entire position (not simply limited to the size of the initial deposit). It should be remembered, however, that this potential for gains also translates to an increased potential for losses, so leveraged trading should be approached with a good deal of caution.
What are Listed and Unlisted CFDs?
The clearest difference when looking at listed and unlisted CFDs is that a listed one is traded on a common stock exchange, such as the S&P 500. This listing affords traders some added protection in that listed CFDs tend to operate in a more transparent manner and are subject to strict trading regulations. Another important factor is that listed will often provide a guaranteed stop loss on each position without any additional costs. This helps to ensure that traders will not be able to lose more than what was initially deposited into the margin account, even during times of heightened volatility in the markets. Because of this, it could be said that listed CFDs create the potential for unlimited upside gains, while potential losses are defined within strict parameters.
Are CFDs Different from Spread Trading?
When looking at CFDs and traditional Spread Trading, there are four major differences that can be seen:
First, gains made with CFD trades are subject to Capital Gains Tax. Losses can also be factored-in relative to Capital Gains liabilities. When dealing with Spread Trading, gains and losses will not be considered when accounting for Capital Gains requirements.
Second, CFDs offer more flexibility in terms of when positions are closed. With Spread Trading, positions are closed based on a predetermined closing date which cannot be altered without additional provisions. This is an advantage for CFDs as positions can be closed based on current market behavior that is more up-to-date.
Third, CFD trades are usually subject to commission charges, while this is not the case when Spread Trading. Commissions are often priced directly into the spreads seen in each trade.
Fourth, long positions in CFD trades allow the investor to capitalize on dividend payouts associated with the underlying asset. It should be remembered, however, that short positions might require traders to actually pay a proportion of this dividend, so this must be considered when looking to establish new CFD positions in long term CFD strategies. Spread Trading does not factor-in dividend yields when positions are established.
Are there limitations when Short Selling CFDs?
There are limitations in some stock markets, as some brokers will only allow traders to short European and British stocks that have a market cap of 200 million in local currency. In US markets, some restrictions apply for companies with a market cap of less than $1 billion. There are also instances where short selling is restricted during times of excessive market volatility.
Which financial instruments are commonly offered?
There is currently a wide variety of instruments that are offered by brokers. Some of the most common include Listed CFDs, Bonds corporate bonds as well as gilts), ETFs (Exchange Traded Funds), ETCs (Exchange Traded Commodities), PIBS (Permanent Interest Bearing shares), REITs (Real Estate Investment Trusts), Options, Futures, and Foreign Exchange (Forex).
What is LIBOR?
LIBOR is an acronym for the London Inter-Bank Offered Rate, which is the rate banks use to lend one another and is regulated by the British Bankers Association. Essentially, what this means for traders is that the LIBOR is the basis used to calculate overnight interest charges for CFD trades that are held longer than one day. Interest charges are different for long positions and short positions, so these fees should be considered when individual trading plans are structured.
What is a Stop Loss and is it always guaranteed?
A Stop Loss is a market order that allows you limit trading losses by setting a price that will automatically close your position if price activity works against the trade. The stop loss will execute a sell order (in long positions) or a buy order (in short positions), closing your position at a predetermined loss level. This level can be derived in tick values, percentage movements, or in Dollar values and this will prevent excessive losses from accruing later.
Not all stop losses, however, are guaranteed. This is why it is important to carefully read your broker’s trading agreement before any trades are made. Guaranteed stop losses typically require brokers to charge more in spread fees, but this is viewed by many as a clear advantage when markets become volatile.
What are the risks involved in CFD trading?
CFDs trades, like any investment, carry with them a significant risk level, and because of this new traders should not invest money in excess. Market prices in all asset classes can be subject to unexpected volatility and sharp reversals in trend direction. For this reason, CFD brokers will require you to sign the company’s risk notice before any trades can be placed.
What are the common dealing hours CFD brokers?
In some cases, the dealing hours are dependent on the operating hours of the underlying asset markets but many of the asset categories that are available will be offered for trade on a 24-hour basis during the week.
What documents will I submit when I open my CFD account?
CFD brokers will require that you provide an original form of identification, such as a current passport, driver’s license, formal tax receipt, or social security card. In addition to this, address verification will be performed using a recent utility bill, mortgage receipt, bank statement or credit card bill.
