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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?

When 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, treasuriescurrency pairscommodities 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 deposited

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Learn about margin

What are the costs of CFD trading?

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 Singapore-based shares on the CMC Markets CFD trading platform start from 0.10% of the full exposure of the position, and there is a minimum commission charge of $10. View the examples below to see how to calculate commisssions on share CFDs.

Example 1 - Opening Trade

A 12,000 unit trade on Company ABC at a price of $1.00  would incur a commission charge of $12 to enter the trade:
12,000 (units) x $1.00 (entry price) = $12,000 x 0.10% = $12.00

Example 2 - Opening Trade

A 5,000 unit trade on Company ABC at a price of $1.00  would incur the minimum commission charge of $10 to enter the trade:
5,000 (units) x $1.00 (entry price) = $5,000 x 0.10% = $5.00    $10.00 (As this is less than the minimum commision charge for Singapore share CFDs, the minimum commission charge of $10 would be applied to this trade.)

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)

In this example,  Singapore Company ABC is trading at $0.98 / $1.00 (where $0.98 is the sell price and $1.00 is the buy price). The spread is 2.

You think the company’s price is going to go up so you decide to open a long position by buying 10,000 CFDs, or ‘units’ at $1.00. A separate commission charge of $10 would be applied when you open the trade, as 0.10% of the trade size is $10 (10,000 units x $1.00 = $10,000 x 0.10%).

Company ABC has a margin rate of 10%, which means you only have to deposit 10% of the total value of the trade as position margin. Therefore, in this example your position margin will be $1,000 (10,000 units x $1.00 = $10,000 x 10%)

Remember that if the price moves against you, it is possible to lose more than your margin of $1,000, as losses will be based on the full value of the position.

Outcome A: a profitable trade

Let's assume your prediction was correct and the price rises over the next week to 110 / 112. You decide to close your buy trade by selling at $1.10 (the current sell price). Remember, commission is charged when you exit a trade too, so a charge of $11 would be applied when you close the trade, as 0.10% of the trade size is $11 (10,000 units x 110c = $11,000 x 0.10%).

The price has moved 10 cents in your favour, from $1.00 (the initial buy price) or opening price to $1.10 (the current sell price or closing 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 ($10 at entry + $11 at exit = $21) which results in a total profit of $979.

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Outcome B: a losing trade

Unfortunately, your prediction was wrong and the price of Company ABC drops over the next week to $0.93 / $0.95. You think the price is likely to continue dropping so, to limit your losses, you decide to sell at $0.93 (the current sell price) to close the trade. As commission is charged when you exit a trade too, a charge of $10 would apply, as 0.10% of the trade size is $9.30 (10,000 units x $0.93 = $9,300 x 0.10%), though the minimum commission is $10.

The price has moved 7  cents against you, from $1.00 (the initial buy price) to $0.93  (the current sell price). Multiply this by the number of units you bought (10,000) to calculate your loss of $700, plus the total commission charge ($10 at entry + $10 at exit = $20) which results in a total loss of $720.

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View more CFD trading examples.

Short-selling in a falling market

With CFD trading it's possible to sell (short) a product if you believe it will fall in value with the aim of profitting from the predicted downward price move. If your prediction turns out to be correct, you can buy the product back at a lower price to make 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 as 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 hold a short position or 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 selling 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.

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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.

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