Why trade CFDs

A contracts for difference (or CFD) is a contractual agreement between a CFD provider and a client to exchange the price difference of a security between the time the contract is made and the time its closed. CFDs are traded on margin which means that they are leveraged instruments ultimately providing traders with more trading resources and flexibility.

Are CFDs similar to Shares?

CFDs are very similar to conventional shares dealing with a few important differences. With a contract for difference you deal based on the actual price of the stock while paying a commission which is computed as a percentage of the value of the market exposure. However, when opening a CFD trade, you do not have to pay for the full market value of the securities. Instead, you make a deposit, referred to as initial margin. Margins can start as low as 1% on some very liquid index instruments and 5% for blue chip shares. A 5% initial margin means that you can leverage yourself up to 20 times your initial sum invested and make your monies work harder for you.

CFDs, unlike traditional shares trading also allow you to buy or sell an instrument, which means that you can take advantage of both bull and bear markets. Additionally CFDs can be used to trade a very wide range of financial instruments covering most global stocks, indices, forex and commodities. For instance, if you have an interest in stocks, the level of the FTSE, the price of Gold and the exchange rate of the UK Pound against the Euro, you can practically deal on all these markets with one CFD broker using one single account. In this stance, contracts for difference provide more flexibility and opportunities than traditional shares dealing.

What about Corporate Actions?

Holders of CFDs are able to participate in corporate actions so any cash dividends, stock splits and rights issues are still adjusted and accounted for in a long share position. The only difference here is that you don’t get any voting rights or franking credits with CFDs. Dividends on a contracts for differences position are received when a long contract for difference position is held overnight over the ex-dividend date. Conversely if a short CFD position is held over this period the holder of the CFD has to pay the dividend. The dividend is credited the day the share goes ex-dividend. Holders of physical stock may be required to wait for up to 40 days or more before receiving a dividend.

Please note, however, that CFDs are geared instruments and can result in losses that exceed your initial deposit and thus may not be suitable for everyone so make sure you fully understand the risks of margin trading.

Successful CFD and stock trader Janice Bollinger publishes a CFD trading guide dedicated to making contracts for differences easier to understand.

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