Knowledge centre | CFDs explained

What is CFD trading?

In practice, it is very similar to buying and selling shares in a traditional share trading account.

The example

If you buy 1,000 shares in company ABC at £5, you have bought £5,000 of stock. If the stock price then rises by 10%, your gross profit is £500. The same is true when you buy 1,000 shares with a CFD.

The risk

The risk of buying 1,000 shares with a share trade or a CFD trade is the same. The potential profit and potential loss is the same. The size of the trade is the same and the value of the share holding is the same (£5,000).

So, why trade CFDs rather than buying the physical shares?

No stamp duty:
With a CFD, you do not buy or sell the underlying stock, so do not take physical delivery of the stock. This means you do not need to pay stamp duty (under current UK legislation, subject to change). Every time you buy a share, you have to pay the government 0.5% of the value of the trade.
Margin flexibility:
CFDs are traded on margin which means you can take positions in the market many times greater than you would with a share trade. Using our example, if the CFD margin requirement is 10%, you could leverage your £5,000 investment up to £50,000. But be aware that trading leveraged products on margin carries a higher level of risk as you can lose all or more of your initial investment.
Long or Short:
CFDs give you the ability to buy if you are bullish about the market or sell if you feel the market will move downwards with exactly the same potential profit.
Order flexibility:
Our trading platform allows you to place automated buy or sell orders in the CFD market to trigger at a certain price, and to instantaneously set stop losses and profit target orders on that position. These automated features increase your ability to apply effective risk management principles on trades.
Risk Management:
The ability to "go short” means that you can fully or partially, hedge your cash stock positions to reduce your overall stock market risk. For example, if you held 500 shares of RBS and wanted to hedge this expsoure, all you would have to do is sell 500 CFDs in RBS against this holding. If the price of the share then decreases the money you lose on the share is offset by the money you make on the short position.

What are the costs?

Every trade will accrue a commission charge. In addition, as your broker is funding up to 95% of the contract value, long positions will attract a funding charge calculated on a spread over LIBOR and short positions will earn interest calculated on a spread under LIBID.
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Are dividends paid?

Despite the fact that you do not take physical delivery of the stock, dividends are still paid to you if you hold CFDs in a company. On long positions you will receive 100% of the dividend and on short positions you will pay out 100% of the dividend.
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Sounds great... but what are the potential Pitfalls of CFD trading?

CFDs can be a great tool to profit from the markets, but they have to be treated with respect. If you buy and sell shares with CFDs, you are going to open up the opportunity to leverage your trade size and may then be susceptible to larger profit and loss swings than you are accustomed to with conventional share trading.
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We urge all clients new to CFD trading to carefully consider setting up risk controls and trading rules before using CFDs. The psychological impact of taking leveraged positions can lead many investors to close out profitable trades early and run losing trades leading to an overall loss on their account value. Whilst trading using CFDs can be a profitable tool, it is important to think carefully about the potential high risks involved if you choose to use some or all of the leverage available when trading shares with leverage (CFDs).