CFD Trading - Background information

CFD Trading has grown rapidly over recent years, fuelled by an increased appetite towards risk and leverage. CFD's, which are also known as contracts for difference, now account for over 30% of trades on the London stock exchange.

CFD Trading enables an individual to take a long or short position on a stock or on an index itself. Because the investor isn't buying the physical stock the trade isn't subject to stamp duty. By trading a CFD you are effectively borrowing money there is an interest charge which is usually Libor + / - 2%. Although there is no limit to the length of time a CFD can be held, most trades are speculative and short term. It is important to note that if you hold a 'Short position' you will be required to pay any dividend due whilst your position is open, and by the same token if you go 'Long' you will receive a dividend if one is paid.

The example below demonstrates how an investor may use a CFD. The smaller capital requirements coupled with the low trading fees enable an investor to exit a position with a very small price movement.

For example –

10000 VOD @ 1.70 = £17,000Deposit required to open position £850 (Required deposit ranges from 5-10% of position depending on the risk profile of the stock)

Purchase Commission 0.25% = £42.5Sale Commission 0.25% = £42.5Trade is profitable above 1.70.85

As you can see from the above example with a deposit of £850 you can be exposed to a £17000 position in Vodafone. If you feel that Vodafone is over priced you could sell the stock 'short' or if you felt confident in the growth of the company you could buy the stock 'long'. Either way, a movement of 1p represents £100 (-/+). If you are in the money you could take the profit but if the price had moved against you could trade. You may be required to deposit more funds into your account to cover the position.

Depending on the mentality and objectives of the trader, he or she may choose to move out of the stock with a small profit or hold out for a certain price target. Many traders will use technical analysis to identify price targets at which to buy and sell stock. This involves looking at areas of support, resistance and also trading volumes in the stock.

CFD's accounts are provided by numerous different companies from high street banks, Brokerage firms and spread betting providers. The different providers charge various levels of commission and offer different levels of support. It is important to consider these factors when choosing a provider. There may also be a number of attractive deals for new clients including reduced commission for a limited period and commission refunds on loss-making trades.