About Contracts for Difference
One of the most effective ways to trade shares is on margin through the use of Equity CFDs or Contracts for Difference. The use of CFDs is becoming an increasingly popular method for trading individual equities without the need to become a registered shareholder or take physical delivery. Equity CFDs now account for 30% of the non-professional share trading volume in UK shares.
There are now numerous instruments available in CFDs, from individual equities to stock indices, foreign exchange and commodities.
Benefits
- Trade without having to pay the total value of the share. Trading on margin provides the investor with leverage or gearing on the capital invested, and frees up capital for other uses. Typically the margin required will be 5-25% depending on the underlying equity, its sector and the exchange where it is traded. For example, with a 10% margin requirement, one can purchase £100,000 of shares with only £10,000 capital employed.
- No share certificates to send or receive.
- Avoid Stamp Duty as clients do not physically purchase shares.
- Ability to enter into a sell position ("Go Short") thereby enabling profit from falling markets.
- Commission Charges that are less than those incurred when trading traditional shares.
- Trade execution and confirmation in seconds.
- Trade at market prices rather than a market maker's
- No expiry date on a CFD, so positions can be held for any length of time. CFDs can be used to protect the short-term value of shares already held, such as those in share option schemes or trusts, without having to sell the actual shares. Trading strategies can be implemented that would otherwise be impractical except to the sophisticated institutional investor.
- Dividend payments or other corporate actions (e.g. rights issues, warrants, stock splits) are reflected in the price development of the CFD, by a cash adjustment.
Example of a CFD trade
Please find below a comparison between trading CFDs and Traditional Shares. Each trader believes shares in BHP Billiton PLC are going to rise in the near future. The stock price rallies from 1000p to 1100p in 10 days.
Client A
He buys £10,000 of BHP Billiton Shares, paying 1,000 shares at 1000p per share. He places the deal with a traditional stock broker paying a standard commission of 1.5% and stamp duty of 0.5%.
Client B
With the Same £10,000 investment, Client B can use the gearing benefits of CFD to acquire 10,000 shares with the same capital employed as initial margin. He pays a commission rate of 0.25% and a funding rate of LIBOR (4.75%) + 2.5%
| Shares (Client A) | CFDs (Client B) | |
|---|---|---|
| Value | £10,000 | £100,000 |
| Commission | £150 | £250 |
| Stamp Duty | £50 | £- |
| Deposit | £10,200 | £10,250 |
The share price now rallies to 1300p and both traders close their respective positions.
| Closing Value | £11,000 | £110,000 |
| Commission | £165 | £275 |
| Funding | £- | £199 |
| Net Profit | £635 | £9276 |
| % Return | £6.35% | £92.76% |
If the share price had gone down, through the leverage used, Client B would have incurred magnified losses. This is why we recommend "Stop Losses" on all positions.