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Investing in the Markets without Buying Shares: CFD Trading

November 22nd, 2009

A CFD (Contract for Difference) is an arrangement between two investors to trade on the difference between the start price and finish price of a contract at the end of an agreed timescale without either party needing to buy the shares themselves. Sounds complicated, but its not really. Many investment groups and hedge funds have found a great deal of success with CFDs for more than ten years in the UK stock market as an alternative means of investment to traditional share dealing. They are many similar comparisions between CFD trading and spread trading in that both of them are margined products so you can gear yourself up or actually take a decision that is a multiple of your available funds.

So for example the margin on a firm youre interested in was 10%, establishing a position of £100,000 would really only require a deposit of £10,000. Any running profits that you make can actually be used as margin to esablish new positions but any losses would have to be made good by reducing your position or by providing extra funds.

While stamp duty of 0.5% on all UK share purchases has in the opinion of some traders reduced the cost effectiveness of ‘day-trading’ traditional stocks and shares, both CFDs and spread betting are exempt and this has added to their appeal. CFDs are liable to capital gains tax whereas spread bets are tax free, but losses incurred from spread bets are gone for good while CFD losses can be offset against any future profits for the purpose of tax. When you trade in CFDs, you purchase those contracts in almost the same way that youd buy shares. So if you wanted exposure to 1,000 shares in a company, youd have to sell 1,000 contracts at, say, 494p per contract rather than simply placing a £10 per point bet with spread betting to get a similar return.

The other difference between the two instruments lies in the flexibility in the bid-offer spread. Most CFD providers allow you to post orders anywhere within the bid-offer spread whereas spread betting firms post their own two-way take it or leave it price exactly as a bookie would. CFDs do not wrap the costs of financing a position within the spread (as does spread betting) but charge those costs and commissions individually. With CFDs the charges and commissions involved in a trade are not part of the spread, which is the case with financial spread betting. Because of this, the CFD spread quote will always be very close to the underlying price of the share or commodity that you are following. CFDs also mimic nearly every aspect of owning the underlying share or market, so if you hold a position for a long enough time period you will recieve the benefit from any dividends being paid on the shares.

CFDs and spread betting have particular features that will appeal to different trading styles and there is no one best instrument to use. Although they should not be regarded as substitutes for long term investment or saving, as more people seek to take control of their financial destiny, theres been a growing realisation that going short is a legitimate means of trading in market thats become increasingly difficult to profit from in a traditional sense.

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