Contracts for Difference Explained

Trade financial markets without the costs associated with traditional investing

When you trade CFDs (Contracts for Difference) you’re not buying physical assets, such as company shares, gold bullion or units in index-tracking funds. Instead you’re agreeing to exchange the difference in the price of an asset over a set time.

CFD trading is suitable for speculating on short-term changes in the value of an asset. For example, you can open and close a position in a matter of minutes, so you can make gains from even short term market fluctuations. Because you’re trading on margin, your capital outlay can be significantly less than compared with traditional forms of investing but your potential losses can be greater than your initial deposit.

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How CFDs work?

CFDs are legal contracts between two parties – usually called the ‘buyer’ and the ‘seller’. Under the contract, the seller pays the buyer the difference between the value of an asset at the time the contract was made, and its value when the contract ends, if the price moved the way the buyer expected.

If the value of the asset doesn’t move the way the buyer expected, the buyer has to pay the seller the difference instead.

Advantages of CFDs

Who uses CFDs?

Like spread betting, CFDs have some tax advantages over regular share dealing, depending on your circumstances. They’re used widely by institutional investors to hedge their positions against unexpected upward or downward swings in market values. However, they’re also popular with professional traders and private individuals looking for a simple way to access global markets without the large initial outlay required with traditional investing.

For the individual investor, CFD trading provided great degrees of flexibility: you can trade at times when it suits you, and leverage can allow you to ‘multiply’ the potential profit. If you’re interested in the financial markets, Spread Co offers the ability to trade a diverse range of products using CFDs, wherever you are.

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Trading on margin

With CFDs your initial outlay to open a trade is significantly less than the full value of the asset you’re trading on. This initial outlay is known as the margin. CFD margins are expressed as a percentage of the asset’s full value, and can be as low as 3.33% depending on the type of asset. This low entry cost makes CFD trading attractive for many types of trader.

Leverage and CFDs

Investing directly in an asset, such as a company share, lets you enjoy the full benefit of any rise in the asset’s value. It’s the same with CFDs but you don’t have to make the same, possibly large, initial outlay to access this potential benefit. This is known as using leverage. Leverage magnifies your potential return – you can make the same profit as a share owner with much lower capital outlay compared with purchasing shares.

You should remember that potential losses can be greater than your initial outlay if the asset price doesn’t move in the direction you anticipated.

Hedging your portfolio with CFDs

If you have a portfolio of shares you may be concerned that it may lose some of its value when prices are falling. CFDs can help you offset these potential losses and can be particularly useful in volatile markets. Let’s say you have 10,000 shares in a UK blue chip company. You can ‘match’ that by going short 10,000 contracts on the same company. If the share price falls by 5%, the reduction in value of your share portfolio can be offset by the gain you’ll make with your CFD trade.

Going long or short

When markets and asset values fall, the value of a share portfolio is likely to fall too, and traditional share investors may suffer a loss. CFDs are different because they give you the potential to make profits when market value rise or fall. By going long (buying) you can make profits when prices rise and by going short (selling) you can make a profit when prices fall.

No stamp duty

Because CFDs don’t attract any Stamp Duty you can make a small saving on every trade, compared with buying shares. And it’s worth remembering that any losses you make on your CFD trades can be offset against other investment gains you make in the same tax year, which could have an impact on any Capital Gains Tax liability*.

Trading CFDs with Spread Co

With Spread Co you can trade CFDs on a huge range of markets. Our online CFD trading platforms are easy to use and give you live pricing to help you plan your trades. You’ll also have access to our powerful charting features.

Take a look at our trading platforms.

These CFD trading examples show how your trade is calculated based on spread size and margin requirement, including potential profit or loss that could be made, based on theoretical trades.

Equity Example

Our price for Vodafone shares is 193.02 (Bid) and 193.41(Offer). Our spread on this trade is 0.075% each way, in addition to the underlying market spread.

You decide to go short on 5,000 contracts. You place a limit order of 175p and a stop loss of 200p.

Your margin

For your 5,000 contracts your margin is calculated as:

NUMBER OF CONTRACTS  x  (MID PRICE / 100)  x  5%

So,

5,000  x  (MID PRICE / 100)  x  5%  x  £483.05

Possible Outcome

Vodafone’s share price falls to 175p (your limit order value) Vodafone’s share price rises to 200p (your stop loss value)
Original bid price minus your limit price multiplied by number of contracts Original bid price minus your stop price multiplied by number of contracts
(193.02p – 175p) x 5,000 (193.02p – 200p) x 5,000
Financing = £0 (0% financing on index positions) Financing = £0 (0% financing on index positions)
Profit £901.00 Loss £349.00

Trade with Spread Co

When you trade equity CFDs with Spread Co

  • Margins are as low as 5%
  • Our additional spread, at 0.075% each way is typically lower than our competitors’ commission charges

When you spread bet on commodities with Spread Co

  • Margins are as low as 1% on commodities
  • Spreads are fixed 24 hours a day
  • No financing charges on futures contracts

Commodity Example

Our price for US Crude Oil futures is $107.20 (Bid) and $107.24(Offer). Our spread on this market is 4 points.

You decide to go short on 100 contracts. You place a limit order of 102 and a stop loss of 110.

Your margin

For your 100 contracts your margin is calculated as:

NUMBER OF CONTRACTS  x  MID PRICE  x 3%

So,

100  x  107.22  x  3%  =  £321.66

Possible Outcome 

Crude oil price falls to $102 (your limit order value) Crude oil price rises to $110 (your stop loss value)
Original bid price minus your limit price multiplied by number of contracts Original bid price minus your stop price multiplied by number of contracts
($107.20 – $102) x 100 ($107.20 – $110) x 100
Financing = £0 (0% financing on futures positions) Financing = £0 (0% financing on futures positions)
Profit £520 Loss £280