A CFD, or Contracts For difference or a Contract For difference is a popular form of derivative used in trading and investing. An arrangement is made in financial derivatives trading where the differences in the settlement between the open and closing trade prices are cash settled. This stipulates that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time. There is no delivery of physical goods or securities with CFDs. CFD trading enables the trader to speculate on rising or falling prices in global financial markets, such as forex, indices, commodities, shares and treasuries. In the case of stocks, they are adjusted for dividend payment as necessary.
For more information see CFDs Made Simple: A Beginner’s Guide to Contracts for Difference Success by Jeff Cartridge and Ashley Jessen.
CFD Example
How to Trade Contract for Difference
In this example we use a UK based Company and currency as CFD’s are not available in the USA. A quote from Plus500 shows us Glaxo is trading at 1,600 – 1,610. That is, 1,600 pence is the sell price and 1,6100 pence is the buy price. Hence, the spread is 10.
The trader decides to open a long position by buying 1,000 CFDs, 1,610 pence. If the commission is 0.10%, the total commission is
1,000 * 1,610 * 0.10% = £100.
If Glaxo has a margin rate of 3%, then you only have to deposit 3% of the total value of the trade as position margin. In this example, with the use of leverage, the margin will be
1,000 * 1,610p * 3% = £483.
If the stock rises by 50p the CFD quote will move to 1,650 – 1,660. The trader can now sell and realize a profit of 40 x 1000 CFD’s less two sets of commission = 200 GBP. This produces a return of 41.41% on the initial investment of 483 GBP.
