Introduction to CFD (Contracts For Differences) Trading
Author: Financial-edu.com
What are CFDs?
CFDs (Contracts For Differences) are basically another form of financial derivative. Unlike the other derivatives, CFDs is highly accessible to any investor/trader/speculator. A Contract For Difference (CFD) is a contract between a buyer and a seller to pay the difference between the buy and sell price based on an underlying instrument when the contract is settled.
The concept is best explained by comparing a CFD on shares against physical shares:
CFD Capital Available:$1030 Buy $10,000 worth of XYZ CFDs at 10% margin Deposit 10% of $10,000 = -$1000 Commission of -$30 Sell $11,000 worth of XYZ CFDs at 10% margin Receive $1,000 for price differnce = +$1,000 Return of 10% deposit = +$1,000 Commission of -$30 8% p.a. interest cost on implied Loan of $10,000 = (.08*3/12*10000) = -$200
Profit = -1000 -30 +1000 +1000 -30 -200 = $740
Share Capital Available:$1030 Buy 1000 XYZ Share at $1 on 30/6/05 = -$1000 Commission of -$30 Sell 1000 XYZ Share at $1.1 on 30/9/05 = +$1000 Commission of -$30
Profit = -1000 – 30 + 1100 -30 = $40
I have made many assumptions in giving the simplified cfd trading example above. Please note that it could just as easily been a very large loss in the CFD, the example serves to show the magnifying impact of leverage.
