Contract for Difference (CFD) is the agreement between two parts to exchange the difference between the opening value and the closing value of an instrument.
CFD is an example of margin trading which allows you to take more profit as you use the leverage. It means that an investor can buy CFD even if he does not have the whole value to purchase shares. For example, to buy the Microsoft shares at the amount of $10,000 you need a deposit of only $1,000. If you take a profit of $1,000 your return is 10% if you trade the underlined shares, but you have 100% of return if you trade CFD. But you must be aware that losses are calculated the same way.
We can say that contract for difference can be qualified as purchasing shares on the proceeds of the credit. If you trade CFD you get all the benefits of underlining share, including price rise and dividends, and pay off on-credit expenditures to the seller. It is a sort of a bank credit: you borrow money to buy shares and get the benefits of a shareholder and bank takes an interest. CFD presents this process as a single deal.
Main advantages:
Short trading. Contract for Difference appeals to short sellers. From the point of view of the value the short trading becomes more effective, and from the point of view of execution it becomes much easier as against to the conventional share trading.
Low commissions and margin requirements. You can make transactions even if you do not have the whole value of the trade. You are only required to lodge a percentage of the value, known as margin and it is typically between 5 and 10 %. So, you can trade a full portfolio of shares without having to tie up large amount of your capital.
Market prices. You trade with the market spread so you are quoted the same prices as the stock markets professionals.
High-speed execution. Your transactions will be executed at the moment you give an order without any delays.
Markets. At present time you are allowed to trade shares, listed in Dow Jones Index, ETFs and futures. The range of instruments is subject to change.
Contract size. Minimum contract size is 0.1 lot = 10 shares. In this case the margin is $10-150 (depending on the price of the share). The margin for the minimal contract to trade on US Stock Exchange is around $35-70 (valid for the end on February, 2003).
Hedging strategies. If you are a shareholder, and you do not intend to sell your shares even if the price fall, you can open a short position on CFD on any share (or the whole portfolio). As a result your losses on the basic asset will be compensated by the profit on relevant CFD.
If you trade CFD you do not get dividends as real shareholders as you deal with "Dividend Adjustment". This means that on the day called ex-dividend date if you have open positions your account will be credited or debited to reflect those adjustments. If you have long position the adjusted amount is credited, if you have short position it is debited. Dividend adjustments are calculated at the same basis as share dividends. For more information about the dividends apply to the page: "Dividends for CFDs on shares".
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