How To Use CFD – Guide For Beginners

How To Use CFD - Guide For Beginners

Short defensives

There are several reasons why you can continue to own shares that you will sell in an ideal world. In the worst situation, you’re bullish in the long run, but in the short term, you’re bearish.

Conversely, you would face a hefty tax burden on capital gains if you wanted to sell. Alternatively, through a mutual fund, unit trust client pension plan, you can hold a stock stake. You may have also obtained stock rights from your company, which you can not use yet.

Whatever the reason, selling a contract for difference (CFD) will protect you from the downside if you want to protect yourself from the risk of a short, sharp plunge in assets that you own. What you need to do, let’s say BSkyB, is to work out your current stock exposure. When you buy £5,000 worth of BSkyB stock, either directly or indirectly, and your broker trades CFDs at 10 percent premiums, then you just need to sell £500 worth of BSkyB CFDs to neutralize your stake.

Turn-up

CFD brokers need to establish that their clients have sufficient standard investment experience before opening an account. The main explanation for this regulatory concern is that the margin lending made possible by CFDs helps individuals to handle up to 100 times their savings.

A typical broker will want you to open an account with a minimum of around £5,000 and offer about 10 percent margin trading. For that initial stake, you could purchase or sell five CFDs worth £1,000 each-which will reflect an investment of £10,000 each of the underlying securities.

In other words, you can enjoy the payoff of up to £50,000 worth of shares with £5,000 of original investment at stake. If you’re optimistic on stocks or shares but lack the initial capital – it could be tied up elsewhere – then CFDs encourage you to borrow money to invest.

Most CFD brokers will allow you to set up between five and ten times (offering 20% down to 10% margin trading). Index CFDs and currency exchange rates will trade at more competitive 7.5 percent margins. Deal4free is unique in delivering margins of as little as 1 percent for new CFD customers. In concrete terms, this means you borrow 100 times your original investment. Only small price changes can have a huge effect on your benefit or loss.

Short / long aggressive

When ‘security first’ isn’t the main incentive, shares that you don’t own can be just as easily short. You may think that a particular share is vulnerable to bad news, pessimistic emotions about the business, or low economic results.

Whatever it is, you should sell a CFD if you believe there is a strong possibility of a minor drop in a share price, and its optimized effect would intensify the small fall into a substantial benefit. For example, the same logic applies in reverse, should you have reasonable reasons for predicting an upward blip in a company’s share.

Dealing between pairs

Two parts of the same business are Royal Dutch Petroleum and Shell Shipping & Trade. Royal Dutch is listed on the Amsterdam Stock Exchange, while Shell is doing business in London. The share prices will, in principle, go up and down in synchronization.

When a difference arises between the two when Shell grows above Royal Dutch (lowering the dividend yield), you will be assured that the phenomenon will rectify itself sooner or later. In that case, you can sell a CFD from Shell and buy a CFD from Royal Dutch.

Despite their utter demand fluctuations, it doesn’t matter what comes next. All stocks could surge or crash – as long as the distance between them narrows, from your long Royal Dutch position, you’d make more money than you gained from your short Shell position.

Yes, this proposed agreement isn’t as easy as it sounds. Disparities between the two stocks have been shown to exist for years, making this an inappropriate pair for CFD trading. This does, therefore, demonstrate the principle.

Another explanation will be the discount on the non-voting stock of Schroders traded in comparison to regular stock. The discount has continued to oscillate between 4 and 12 percent over the last couple of years. CFD traders who speculate on a narrowing discount once it reaches 12 percent or a widening discount would have made money once it reaches 4 percent.

Another common pair exchange includes the Microsoft and SAP tech stocks. A decline in the dollar would harm Microsoft’s earnings, and an increase in the euro would help German-owned SAP’s earnings.

Trading in pairs depends on individual investors’ ability to detect trends in the market, which may continue for years or evaporate overnight. As such, they are hardly ever as risk-free as they show up first.

Common Hedge

When you’ve developed a large portfolio of UK shares mirroring the FTSE 100, otherwise you can sell CFD indices to protect your portfolios. So it’s important to keep a few things in mind.

Next, a trader that sells index CFDs would usually protect itself by purchasing or selling FTSE futures. He’ll apply a spread to the deal, pay rates he’ll be paying, and pass them over to you. That means you’d always be better off playing directly with the future.

Second, monitoring the FTSE’s success is relatively uncommon for a limited portfolio, so there is no need to make it your investment strategy’s target. There are plenty of diversified British equity portfolios that are less volatile than FTSE, which deliver better yields.

Sector Speculations

There are few clear means of speculating on the different aspects of the UK economy. Exchange-traded funds (ETFs) would make perfect instruments if they just had enough. But the expense of developing an ETF means they are sold only on the most common markets, and only then on a pan-European – or even regional – basis.

Yet, there are three CFD dealers selling goods developed around segments of the FTSE industry. City Index, CMC Markets, and IG Markets all offer buyers an incentive to purchase or sell whole companies (usually based on all FTSE 350 stocks in a single field, such as tech, healthcare, or insurance).

For industries of higher than normal uncertainty, or where positive news on one stock can raise confidence in its peer group, sector CFDs can deliver fascinating trading tactics, particularly through the market as a whole is fairly flat.

Surfing the Dividend

The whole idea behind CFDs is that they are meant to give you all the perks of buying stock without the inconveniences (such as paying stamp duty and not being allowed to go short).

The effect of that is that you will be compensated with the dividend (less than 10 percent tax) if you buy an equity CFD when the underlying share goes ex-dividend. Conversely, you’ll have to cough up the dividend in full if you are short of a company that day.

In principle, all of this will come out of the wash, and no net change should be made. The underlying share price will adjust the dividend amount to which owners (no longer) are entitled, up or down.

But the full sum of the distribution may not come back on a stock of strong leverage behind it. A CFD trader who hops in for the dividend, deposits it, and bails out before complete settlement of the share price, will book a tidy profit.

The ex-dividend date for virtually all shares will fall on a Wednesday, and most CFD brokers will send newsletters ‘week ahead’ to their buyers, reminding them of all the shares due to going ex-dividend next week.

Tax saving

What you save by CFDs in postage duty, you will potentially forfeit in charges to pay. When the Bank of England continues to increase UK base rates, you will still be paid by CFD traders’ interest rate on long positions left open overnight. That would shorten the opportunity window.

Yet it’s important to note that if you can deliver massive or regular transactions, virtually any broker should be flexible on commissions and borrowing fees. Moreover, if you can raise your trade margin from 10 or 20 percent to 80 or 90 percent, there is less justification why you would be paid interest by the CFD trader.

Theoretically, if you pay an upfront 100 percent premium (or the whole consideration), the lender does not lend you more money and you will be able to extract a completely zero lending fee.

Save with Spreads

By trading with a business that allows you direct access to Level II markets, you can look at the transactions that go through the electronic order book (sets) of the London Stock Exchange and choose your own price for your transactions. You will have saved yourself the market’s spread if your price is taken up on Sets (see CFDs: Basics).