DEFINITION
An agreement between two parties agreeing to settle at the close of the contract the difference between the opening price and closing price of the contract, multiplied by the number of shares specified in the contract.
Shares on margin, i.e. buying shares and only lodging a security deposit which is typically between 10% - 20%.
A simple example:
In September you might agree to buy 5000 Halifax shares at £6.00 (total value of £30,000). You lodge a 10% margin deposit of £3,000. In November the price of Halifax shares moves to £8.00 say, and you agree to sell at this level. You receive a gross profit of £10,000 (i.e. £40,000 less £30,000) and your deposit is returned. (Note: this is a simplistic example designed to explain the concept only. The full costs and risks of trading are explained below).
BENEFITS
Increased leverage
By using CFDs you are able to control up to 10 times the stock compared with an outright purchase. This higher gearing creates greater profits if you correctly anticipate movements in the stock price, however the risk of loss also increases proportionately if the stock moves against you.
No stamp duty
In some jurisdictions share trading attracts stamp duty however because no physical stock transaction takes place there is no stamp duty payable on CFD transactions under the current legislation. This creates opportunities to day trade stocks without the need to cover the cost of stamp duty.
Easy to sell short
In many jurisdictions it is a complex and difficult process to go short in an individual share. CFDs create the ability to sell quoted shares and the potential to benefit from share price declines.
Risk Management
You have the ability to protect a multi-national portfolio against short-term market falls by selling sufficient CFDs to cover your exposure. If the CFDs are bought back after a decline then the profit achieved should offset the loss incurred on your portfolio.
COSTS:
Commission
The commission varies by market, size and frequency of trading, however it is usually around 0.25%.
Funding
Whilst holding a purchased CFD, your account will be charged daily interest on the amount of the initial contract value. A holder of a long CFD pays interest on the value of the contract, because MF Global Direct has effectively financed the value of the trade. The interest rate charged fluctuates and clients should consult their account executive for the latest rates.
Dividends
If you are holding a purchased CFD then 90% of any dividend payment due on the underlying share will be credited to your account. If you hold sold CFDs you will be debited 100% of any dividend payments.
PLACING ORDERS
Orders are placed online in a similar way to online share dealing. In many cases the confirmation will be immediate for market orders.
MARGIN REQUIREMENTS
The margin charged for CFDs, varies from 10% upwards and depends upon both the volatility of the market and volatility of the individual stock. Positions are marked to market, daily and the initial margin has to be maintained. In cases of adverse market movement investors are liable to pay additional margin. This high leverage means that only experienced traders are able to open CFD accounts.
MINIMUM ACCOUNT SIZE
Our minimum account size is £10,000.
DISADVANTAGES/RISKS of CFD TRADING
The list below does not cover every possible risk associated with CFD trading. It does however list some of the most common risks.
Increased leverage
If you incorrectly forecast the movement in the stock price then the risk of loss increases proportionately if the stock moves against you. If you are paying 10% margin, for example, a move greater than 10% against you will deplete your initial security deposit, whilst you will still remain liable for any additional loss incurred.
Stamp duty
Although at present in some jurisdictions there is no stamp duty payable on CFD transactions this legislation could be changed.
Trading suspended
Occasionally trading in a stock is suspended. In these cases it is likely that you would be unable to trade out of your CFD contract and could be subject to an increased margin demand.
Initial Margin (deposit)
In times of increased volatility or perceived risk the initial margin of a stock can change on short notice. If you are unable to meet the increased margin you will be forced to close your position.
Selling short
If you were to sell short and it were impossible to borrow the stock to cover your position then you would be forced to buy back the stock.
FAQs
How do some brokers offer commission free dealing?
They take something out of the dealing spread when executing the trade. They offer "commission free" by making their own spread around the underlying price.
How long can I hold the position?
Basically you can hold a position for as long as required, however in certain circumstances such as a takeover you could be forced to close out a position.
What is Pair Trading?
It is a market neutral position which is established by shorting one stock while simultaneously buying another. Spreads are usually traded between two stocks in the same business sector or where there is a significant cross holding or correlation. For example you might be more confident about Halifax's (HFX) performance compared to Abbey National (ANL) and bearish about the market generally. If you purchase HFX and sell ANL as long as HFX outperforms ANL you should make money.
Example of a Pairs Trade:
You wish to profit if Halifax's (HFX) out performs Abbey National (ANL) and you have no opinion about the market direction.
The current market prices are HFX £6.00 and ANL £8.00
This could be expressed as a ratio of 6/8 or 0.75. In other words one HFX is equal to .75 ANL. If you buy HFX and sell an equivalent in value of ANL you should profit as long as the ration improves. eg:
Buy a CFD on 10,000 HFX shares at £6.00 (value £60,000)
Sell a CFD on 7,500 ANL shares at £8.00 (value £60,000)
Some time later HFX is trading at £5.60 and ANL £7.00. The new ratio is .80 and suggests that you have made a gross profit which could calculate the profit as follows:
Buy 10,000 HFX at £6.00 sell at £5.60 generating a loss of £4,000
Sell 7,500 ANL at £8.00 buy back at £7.00 generating a profit of £7,500
Gross profit £3,500
CFDs vs Spreads Learn
If you want to trade CFDs, you have 2 basic choices:
Trade through a company that doesn’t charge commission, but adds a spread to the market’s prices.
Use a company that charges commission, but lets you trade on real market prices without added spreads.
Perhaps the most important aspect to successful trading is dealing at the best prices. Some companies do not charge commission, but instead may add, 0.5p to both sides of the price in the stock market. If the price is around 100p, that would be equivalent to charging commission of 0.5% per trade.
The ‘spread’ is the traders biggest cost, yet it never appears on the contract note. With MF Global , the real cost of your trading could be halved!
Once you’ve got used to using Level 2 and trading at prices between the market spread, you won’t want to go back to being told what prices you can deal at and paying big spreads.
Fed up with paying wide spreads?
Fed up with prices being skewed against you?
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