If you don’t know about CFD’s, then here’s a basic primer. A CFD is a Contract for Difference, which is basically an agreement between two parties to settle a contract at the difference between the opening and closing price. For example, if you invest in a CFD in a stock that is priced at $25, and by the time the CFD expires the stock is worth $35, then the amount you make on the CFD is $10. However, unlike trading regular shares, CFDs have a number of advantages. There are also a number of surprising facts about CFDs that make this an attractive way of trading. Here are five interesting facts that you need to know about CFDs.
No stamp duty
Unlike trading regular shares, CFDs are not subject to stamp duty. In places like the US, stamp duty isn’t an issue, but if you are in another country – such as the UK – then stamp duty can really eat into your profits. If you trade in CFDs, then you can save a significant amount of money – 0.5% – compared to buying shares. This is highly attractive, particularly if you are looking to make profits on small price movements, since stamp duty often is more than any profits that you will see in the short term.
Trading on margin
With a CFD, you only need to come up with a small percentage of the opening position, which is known as the initial margin. This is different to stocks – which require you to come up with the full stock price, or at least a large proportion of it. This means that you can take much larger positions than you could trading stocks, which means that you have a larger profit potential – although you may lose more as well.
You can short CFDs
Many people think that CFDs only allow you to take a long position, but this just isn’t true. You can short CFDs just like you short stocks, which means that you can benefit from both upward and downward movements in the market. By shorting CFDs, you get the same flexibility as you do shorting regular shares, and you can magnify your gains because you are using margin.
CFD commissions are related to the number of shares you control
One of the potential downsides of CFDs, however, is that you pay the same commissions as you would if you actually bought the stock. The commission is determined by the number of stocks you control, not by the amount that you pay taking into consideration margin. This means that commission is a higher percentage of your post-margin investment, but it’s no worse than trading equities directly.
Overnight financing costs
Another thing to consider is that CFDs are subject to overnight charges. This is because you are buying on margin. If you have a long position on a CFD, then the amount of interest you pay will be linked to the current LIBOR rate. On the other hand, if you have a short position then you stand to gain – you’ll get interest back based on the same LIBOR rate. However, it’s worth checking what the interest rate is – some brokers offer better interest rates than others.