What is a Contract for Difference - CFDs?
Contracts for difference (CFDs) are a way of trading thousands of global financial markets without paying stamp duty. As with a normal spread bet, you can profit from rising or falling markets by going long or short, so this gives a lot of flexibility.
CFD trading gives the trader the ability to trade a wide variety of markets including stocks, commodities and forex without having to pay stamp duty and without owning the underlying asset.
CFDs are a leveraged product, which means that you only need to put up a small amount of capital against your position. This means that you trade on margin and can gain access to a larger portion of the market than if you bought the instrument directly. This is a two-edged sword as it can increase profits when you are right but also increase losses when you are wrong. Guaranteed stops can be used on CFDs in order to limit losses.
In addition to being able to place guaranteed stops, many other features that are familiar to spread bettors are available, such as the ability to use stop and limit orders. Additionally, orders to open can also be place, meaning that the trader can place a CFD bet to open automatically should the market reach a predetermined level. This saves the trader from having to sit in front of the screen all day long monitoring the markets.
CFDs can be traded 24 hours a day, even when the underlying asset is closed. Additionally, with CFDs you can keep trades open as long as you want as most CFDs have no expiration.
Many spread betting companies such as City Index offer CFD trading, although there may be a requirement to open a separate CFD account. Most spread betting companies offering CFD accounts will also offer apps for trading CFDs.
The mechanics of placing CFD trades are very similar to placing spread bets. As with spread betting, prices are quoted as buy (offer) or sell (bid), so if you go long, you buy the offer price and if you go short, you sell the bid price. Similarly, the prices of CFDs reflect the prices of the underlying instrument as they do in traditional dealing.
Therefore if you think the market will rise and wish to profit from your insight, you would buy. If you thought the market was going to decline, you would sell the market to profit from the fall.
One difference between spread bets and CFDs is that instead of placing a bet per point as you would in spread betting, you buy contracts, or multiple contracts. Obviously the more contracts you buy the larger your position is, which is the same as placing a larger bet per point when spread betting.
Unlike spread bets, CFDs are not tax free. However, they can be tax efficient if you lose as you can offset your losses against your Capital Gains Tax liabilities. However, if you do win, your profits are taxable.
CFDs do attract commissions on stocks, but are generally commission free on non-equity products, but in these cases they incur a wider spread. This will vary depending on the platform used.
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