What is a contract for difference?
A contract for difference (CFD) is a popular form of derivative trading. CFD trading enables you to speculate on the rising or falling prices of fast-moving global financial markets (or
instruments) such as shares, indices, commodities, currencies and treasuries.
Among the benefits of CFD trading are that you can trade on margin, and you can go short (sell) if you think prices will go down or go long (buy) if you think prices will rise. You can also
use CFDs to hedge an existing physical portfolio.
How do CFDs work?
hen you trade CFDs, you don’t buy or sell the underlying asset (e.g. a physical share, currency pair or commodity). We offer CFDs on thousands of global markets and you can buy or sell a
number of units for a particular product or instrument depending on whether you think prices will go up or down. Our wide range of products includes shares,
treasuries, currency pairs, commodities and
stock indices, such as the Singapore Free.
For every point the price of the instrument moves in your favour, you gain multiples of the number of units you have bought or sold. For every point the price moves against you, you will make a loss. Please remember that losses can
exceed your deposits.
What is margin and leverage?
CFDs are a leveraged product, which means that you only need to deposit a small percentage of the full value of the trade in order to open a position. This is called ‘trading on margin’ (or
margin requirement). While trading on margin allows you to magnify your returns, your losses will also be magnified as they are based on the full value of the position, meaning you could lose more than any capital
Spread: As in all markets, when trading CFDs you must pay the spread,
which is the difference between the buy and sell price. You enter a buy trade using the buy price quoted and exit using the sell price. As one of the leading CFD providers globally, we understand that the narrower the spread, the
less you need the price to move in your favour before you start making a profit or loss. Our spreads are therefore always competitive so you can maximise your ability to net a potential profit.
Holding costs: At the end of each trading day (5pm New York time), any positions open in your account may be subject to a charge called a 'holding
cost'. The holding cost can be positive or negative depending on the direction of your position and the applicable holding rate.
Market data fees: To trade or view our price data for share CFDs you must activate the relevant market data subscription for which a fee will be charged. View our
CFD market data fees.
Commissions (only applicable for shares): You must also pay a separate commission charge when you trade share CFDs. Commissions on AUS-based shares on the CMC
Markets CFD trading platform start from 0.09% of the full exposure of the position, and there is a minimum commission charge of $7.
Example 1 - Opening Trade
A 12,000 unit trade on AUS Company ABC at a price of $1.00 ot 100 cents would incur a commission charge of $10.80 to enter the trade:
|12,000 (units) x 100 cents (entry price) = $12,000 x 0.09% = $10.80
Example 2 - Opening Trade
|A 5,000 unit trade on AUS Company ABC at a price of $1 or 100 cents would incur the minimum commission charge of $7 to enter the trade:
|5,000 (units) x 100 cents (entry price) = $5,000 x 0.09% = $4.50As this is less than the minimum commission charge for AUS share CFDs, the minimum commission charge of $7 would be applied to this
Please note: CFD trades incur a commission charge when the trade is opened as well as when it is closed. The above calculation can be applied for a closing trade,
the only difference is that you use the exit price rather than the entry price.
Learn more about CFD trading costs and commissions
Example of a CFD trade
Buying a company share in a rising market (going long)
You think the company’s price is going to go up so you decide to buy 1,000 CFDs, or ‘units’ at $10.00. A separate commission charge of $9
would be applied when
you open the trade, as 0.09% of the trade size is $9 (1,000 units x $10.00 = $10,000 x 0.09%).
Company ABC has a margin rate of 3%, which means you only
have to deposit 3% of the total value of the trade as position margin.
Therefore, in this example your position margin will be $300 (1,000 units x $10.00 = $10,000 x 3%)
Remember that if the price moves against you, it is possible to lose more than your margin of $300, as
losses will be based on the full value of the position.
Outcome A: a profitable trade
Your prediction was correct and the price rises over the next week to $11.00 / $11.02. You decide
to close your buy trade by selling at $11.00 (the current sell price). Remember, commission is
charged when you exit a trade too, so a charge of $9.90 would be applied when you close the trade, as 0.09% of the trade size is $9.90 (1,000 units x $11.00 = $11,000 x 0.09%).
The price has moved $1.00 in your favour, from $10.00 cents (the initial buy price) to $11.00 cents (the current sell price). Multiply this by the number of units
you bought (10,000) to calculate your profit of $1,000, then subtract the total commission charge ($9 at entry + $9.90 at exit = $18.90) which results in a total profit
Outcome B: a losing trade
Unfortunately, your prediction was wrong and the price of Company ABC drops over the next week to $9.30 / $9.32. You think the price is likely to continue dropping so, to
limit your losses, you decide to sell
at $9.30 (the current price) to close the trade. As commission is charged when you exit a trade too, a charge of $8.37 would apply, as 0.09% of the trade size is $8.37
(1,000 units x
$9.30cents = $9,300 x 0.09%).
The price has moved 70 cents against you, from $10.00 (the initial buy price) to $9.30 (the current sell price). Multiply this by the number of units you bought (1,000)
to calculate your loss of $700, plus the total commission charge ($9 at entry + $8.37 at exit = $17.37) which results in a total loss of $717.37.
Short-selling in a falling market
If you decide to sell a product that you believe will fall in value and your prediction turns out to be correct, you can buy the product back at a lower price at a profit. If you are
incorrect and the value rises, you will make a loss. This loss can exceed your deposits.
Hedging your physical portfolio
If you have already invested in an existing portfolio of physical shares with another broker and you think they may lose some of their value over the short term, you can hedge your physical
shares using CFDs. By short selling
the same shares in CFDs, you can try and make a profit from the short-term downtrend to offset any loss from your existing portfolio.
For example, say you hold $5,000 worth of physical ABC Corp shares in your portfolio; you could short sell the equivalent value of ABC Corp with CFDs. Then, if ABC Corp’s share prices fall in the underlying market, the loss in
value of your physical share portfolio could potentially be offset by the profit made on your short sell CFD trade. You could then close out of your CFD trade to secure your profits as the short-term downtrend comes to an end and
the value of
your physical shares starts to rise again.
Using CFDs to hedge physical share portfolios is a popular strategy for many investors, especially in volatile markets.
Attend one of our regular CFD trading webinars or seminars and improve your CFD trading skills.
CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or
objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the
author that any
particular investment, security, transaction or investment strategy is suitable for any specific person.