Investing with CFDs: how it works

Contract for difference (CFD) trading offers investors the opportunity to trade on shares, indices, currencies, commodities and bonds using leverage; that is, they can trade on markets with a deposit (referred to as ‘margin’) that is only a fraction of the total notional value of the trade.

An example

Here is an example. The minimum margin requirement for FTSE 100 shares is 3% (other providers may differ), so if an investor bought 10,000 CFDs of Vodafone at a price of £1.50, they would require a minimum of £450 in their account in order to open the trade ([10,000 x £1.50] x 3% = £450) as opposed to £15,000 had they bought 10,000 shares through a stock broker.

How it compares with spread betting

Financial spread betting and CFD trading are not dissimilar. For example, both are leveraged derivative products that are exempt from stamp duty. However there are some key differences.  Under current UK law, neither may be subject to stamp duty. However where spread betting is exempt from capital gains tax, CFD trading is not.  The flip side to this is that any loses incurred via spread betting cannot be offset against other capital gains whereas with CFD trading they can.

The other key distinction is that with spread betting you are using a stake denominated in pounds, so if you buy Google in a spread bet you are not exposed to any change in value of the dollar.  With CFDs your profit or loss is not only determined by the fluctuation of Google’s share price, but by the rise and fall of the US dollar.

Risk

As with any products that involve the financial markets they are inherently risky. CFD trading is leveraged so whilst it can lead to greater returns on smaller deposits, it is also possible to lose more than your deposit. Investors should also look at the price of commission as many CFD providers have a commission charge.

Some platforms, such as Capital CFDs, attempt to mitigate the risks of trading by applying automatic stop losses to every trade; however stops are not guaranteed. Investors can of course amend the level of their stop loss.

CFD trading isn’t for everyone.  You should ensure it meets your investment objectives and if necessary you should seek independent advice.

Angus Campbell is head of sales at Capital Spreads