What is CFD Trading

What is CFD Trading

What is CFD?

A contract for difference, otherwise known as a CFD, is an agreement between two parties (investor and CFD provider) to exchange the difference between the opening and closing price of a contract. CFDs are derivative products that allow investors to make assessments of rising and falling markets, including forex, indices, metals, commodities, treasuries and shares with ADS Prime.

CFDs are a leveraged product and can be used as a hedging device to offset losses incurred in your physical portfolio of shares. CFD trades are free from stamp duty and through ADS Prime, you will have access to some of the tightest spreads, lowest margins and competitive commission rates.

How to trade CFDs

In the same way as traditional trading, there will be a bid and an offer price. In order to complete a round turn, both a buy and sell action must occur.

If you anticipate that the value of a market will increase, you will BUY to open and later SELL to close. If you close at a higher price than the opening, then you will make a profit, however if you close at a lower price then you will make a loss. When you SELL to open, then it would be the same process however the opposite way around. Therefore you would be aiming to BUY back at a lower price than the one that you opened at in order to be profitable on the trade.

A CFD will be traded in the underlying currency of the symbol, unless otherwise specified on our market information sheet.

For single stocks in CFDs, 1 lot would represent 100 shares but would make or lose the client £1 per pence movement in UK shares and $1 per cent movement in US shares.

Example of an Index CFD trade:

There is a major data event in the US. You anticipate that US indices should rally following this event and you want to buy 10 Dow Jones US 30 CFDs at the offer price of 16369.73. Each point movement will equate to a 10 USD profit or loss.

Assuming 1:500 leverage, the margin required to open this position is (16369.73*10)/500 = 327.39 USD

Huge volatility is expected following the release of the data. You do not set a stop-loss or take-profit orders, but instead you intend to close the position shortly after the data release event.

When the data is released, there is major buying activity and a subsequent increase in the value of the index. The market bid price is now quoted at 16600.00 and you decide to close your position.

To calculate your profit, you calculate the difference between the opening and closing price, multiplied by the number of CFDs you held.

(16600 – 16369.73) * 10 = 2302.70 USD

Calculating margin

CFDs are a leveraged product so you are able to enter a trade with greater exposure than what you would do if you were to hold the actual stock for example. Whilst this can result in significantly larger gains if the market moves in your favour, you need to consider that if the market moves against you, it will increase your potential losses accordingly.

When the margin requirement is given as a percentage, you need to multiply the price by the quantity, then multiply by the margin percentage.

When the margin is given as a ratio; multiply the price by the quantity and then divide by the leverage.

For example if Vodafone are trading at 225 and you buy 100 CFDs (10,000 shares) at a 5% margin requirement then you will do the following calculation:

  • 225*100 = 22,500
  • 22,500 * 5% = £1125

Remember to multiply by 100 for US Shares as you are trading per cent movement and US Shares are quoted in dollars.

Daily Funding Charges

On non FX positions, daily funding charges will be applied for all products that are not futures contracts. It reflects that this is a daily product that has been moved to the next day and not a futures product where the spread would be wider to incorporate these costs.

ADS Prime offers a financing rate of 250 basis points. The financing cost will be the exposure of your trade, multiplied by our rate, above or below LIBOR. You will + LIBOR for long positions, and – LIBOR for short positions.

To calculate the daily charge, it can then be divided by 365 or 360, depending on the market traded.

The following calculation can be used: (Price * Quantity) x (2.5 +/- LIBOR) / number of days

Please note that although you may expect to receive financing on short positions, global interest rates are currently so low that you are likely to still be charged. As interest rates rise, short positions may receive funding. Long positions will always incur this charge.

Dividend Credits and Debits

All CFDs will be liable for dividend adjustments, this is because when a stock pays a dividend, it will affect the price of the share and any index it is associated to. Each stock will normally pay a dividend twice a year however, since you do not own the shares, you will be adjusted for the dividend amount to counteract the price movement. This means that you are neither advantaged nor disadvantaged by dividends when trading a derivative product.

Within the FTSE 100, the companies are very different sizes and size buys influence. The larger the company, the more weight it is given in the Index. Size is measured by market capitalisation which is the value of all the shares added together. The larger the market capitalisation the bigger its percentage of the index, and this is taken into account when dividend adjustments are made on an index.

As an example, when Barclays paid a dividend of 4 UK pence, this equated to 2.49 points on the UK100.CASH. Then there was Rio Tinto who paid a dividend of 6 UK pence but this equated to 2.87 points on the UK100.CASH.

Trading Example

Short Gold

You feel that a correction is due in the price of gold. You decide to sell (go short) 10 XAU/USD (gold/US dollar) at 1244.26.

content-example-short-gold

10 points = 1000 ounces. Your total exposure is 1244.26*1000 = $1,244,260

Each tick is worth $100 and each point $1,000. Assuming 1:200 leverage the margin required to open this trade is (1244.26*1000)/200= $6,221.30 USD

The dollar strengthens during the day, driving gold prices to 1230.00/1230.30. You decide to close your position and take the profit. You sold at 1244.26 and closed your position at 1230.30, up 13.96 points.

Your net profit is (1244.26-1230.30)*1000 = US$13,960.

Long US Crude

Conflict in the Middle East has raised volatility in oil markets. You expect a strong acceleration in prices and decide to go long (buy) 1 US Crude Oil at 8183.40. 1 point is worth $1.

US Crude CFD

Conflict in the Middle East has raised volatility in oil markets. You expect a strong acceleration in prices and decide to go long (buy) 1 US Crude Oil at 8183.40. 1 point is worth $1.

You set a trailing stop-loss 10 points away intending to lock in any profit if the market gains momentum.

The market moves 20 points in your direction to 8203.40/8206.20. Your stop-loss also moves 20 points to 8193.40.

The market is still very volatile and prices reverse suddenly, hitting your stop-loss at 8193.40.

Your profit for this trade is (8193.40- 8183.40) * 1 = 10 USD.

Learn more about CFD trading

Our online training tools include videos and webinars to help you understand and manage trading risks, including using “stop-loss” and “take-profit” limits to minimise potential losses.

Find out more on our Learn page