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CFDs (contracts for difference) trading allows investors the ability to go long or short and the opportunity to make money in a falling market without the need to put up large amounts of capital, making them a more flexible way of investing. CFD trading is often used for speculative purposes. CFDs can be used to speculate on the future movement of market prices whether the price of the underlying product is rising or falling.
CFDs are leveraged products that allow you to trade while only paying a fraction of the total value of the contract. When you trade a leveraged product, you can potentially magnify your return on investment. But with great potential returns also comes greater risk. The higher leverage can result in losses that could exceed your initial deposit.
Investors can use CFDs to gain instant exposure to major global markets including the UK, US, Europe and Asia. See our range of CFD trading markets.
Gains from CFDs are eligible for Capital Gains Tax as unlike Spread Betting it is not regarded as gambling. However any losses incurred through the trading of CFDs become tax deductible.
CFDs are generally offered for margin trading, which means that traders are only required to deposit a portion of the actual trade size in each transaction. For example, if you have a CFD trade worth £1,000 (either in a short or long position) and your provider’s margin requirement is 4%, this would mean you only need £40 to open the position.
It is generally recommended that less experienced traders use smaller lot sizes until they have developed a successful trading strategy that is more consistently profitable. More experienced traders can choose to put more capital at risk so that they do not feel limited in the way their trades are structured.
One method that traders use to limit potential risk during market volatility is the implementation of ‘hedged’ positions. For example, if you have a long position on a CFD that is accruing losses, you can open a position in the opposite position using a short CFD.
A contract for difference, or in short, a CFD, is a popular form of derivative trading. CFD trading allow traders to speculate on the price movement of a large array of financial markets such as shares, indices, currencies, bonds and commodities, independently of whether the price is going up or down.
While a contract for difference is directly linked to the share price of a financial instrument, CFD traders do not actually buy or sell the underlying security. The CFD simply mirrors the movement and pricing of the underlying instrument. As you do not actually own the underlying instrument, you do not pay UK Stamp Duty.
By putting down a relatively small amount of funds known as margin for the CFD, the trader gains access to the movement in the share price. CFDs are generally traded as leveraged investments where only a fraction of the underlying value of the instrument is put down as margin. Margins for CFDs range from 1-100% of the underlying value, with margins for currencies and indices being as low as 1%.
This margin allows you to control positions that are up to 100 times greater than your actual commitment giving you the opportunity to reap profit based on a 100% investment while only putting up 1% as margin, hereby magnifying your market exposure. It is important to remember that any potential losses will be amplified in the same way, so if you get your trading strategy wrong, your losses will be similarly greater because your investment is leveraged.
As an example, if you buy a currency CFD that requires only 1% margin to open a position, a mere 1% change in the market price of the underlying currency pair will generate a 100% profit or loss in the investor’s capital. But while there is potential to make significant profits, the market can just as quickly go the other way and lead to equally significant losses, so it is important to be cautious.
In contrast to options and futures contracts, a CFD contract does not have an expiry date. Instead a CFD is renewed at the close of each trading day and rolled forward unless closed. It is possible to run positions indefinitely as long as you keep enough margin in your account to keep the position open. In this respect CFDs are very similar to futures without an expiration date. The contract will remain open, and you will just settle any outstanding interest and dividends with your broker at the end of each trading day.
One of the features that make CFDs trading so attractive is the ability to go both long and short. You don’t have to buy a CFD before you sell it. If you believe the price of a CFD contract for difference is going down, you can sell it only to buy the CFD at a later point in time when you decide to close it. It is important to keep in mind that while you are long a CFD, you will receive dividends and pay interest and vice versa if you are short. You pay commission both when you buy and sell a CFD. You can close your position at any point in time.
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Trading the long side in practice means that you have used a buy instruction as your opening CFD trade or ‘gone long’. For trading shares ‘going long’ refers to opening a buy CFD position to profit from a share price increase. This implies that you are expecting a rise in the asset’s price and will use a sell order to close your position. Trading the short side means that you have opened your CFD trade using a sell order or ‘gone short’.
‘Going short’ refers to opening a sell CFD position to profit from a share price decrease. This means that you are anticipating stock prices to fall and will use a buy order to close your position (although this may sound a bit strange it is really another way you close out your position in the market). The benefit of short trading is that you can profit directly from falling asset prices, which is difficult to do without the use of products such as contracts for differences.
Leverage allows a client to trade a specific market without being required to deposit the full contract value, whilst having the same underlying risk.
Another way to refer to margin requirement is the leverage offered by a broker. A 2% margin requirement is equivalent to offering 50:1 leverage while a 1% margin requirement can also be referred to as 100:1 leverage.
A hedge is a trade to reduce the risk of adverse price movements on an existing position. Normally, a hedge consists of taking an offsetting position in a related security.
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Hantec Markets Limited would like to make you aware that we have no connection or relationship to Nordhill Capital. We have recently been notified by our regulator they are using our name to promote their services. We wish to state this is done without the permission or authority of Hantec Markets Limited.
Forex, CFDs and Spread Bets are leveraged products which can result in losses greater than your initial deposit. Therefore you should only speculate with money that you can afford to lose.
Please ensure you fully understand the risks involved, seeking independent advice if necessary prior to entering into such transactions. Please click here to view our Risk Disclosure..