allow you to trade individual shares and stock indices without putting up
the full underlying contract value, and offer substantial advantages over
normal share trading - here are the raw unedited 'blurbs' from two brokerage
houses offering the service :
What are CFDs?
How do they work?
According to the technical definitions, a
CFD is 'a contract
designed to make a profit or avoid a loss through the movements in the
price of an underlying item.' That item can be a stock market index eg,
the FTSE 100, a bond, an option, but for the individual investor is most
usually an equity, a share in a company that you do not physically own,
but from which you get all of the associated benefits including dividends.
Since you are not actually buying or selling the shares, CFDs are also
exempt from stamp duty.
When you buy or sell (go long or short) a
CFD, you are entering into a
contract a broker, to exchange the difference between an opening value and
the closing value of a particular financial instrument (share, bond, index
etc.)
In most respects, buying a
CFD mirrors buying the underlying
instrument. In the case of an individual equity you will get dividend
payments for example.
You will basically make a 'call' on whether you think a share, bond, or
index is going to go up or down, and you will buy or sell a
CFD accordingly. If you get it right, the company pays you the
difference between where you bought, or sold, and the current value. If
you get it wrong the
CFD issuer is the winner.
Margin trading
Perhaps one of the major differences between trading CFDs and the
underlying instrument is the fact that you can trade 'on margin.' In other
words the broker will allow you to buy a certain value of CFDs by putting
down a small percentage of the total value. For example, to buy £1,000
worth of shares you may only need to deposit £50 or 5% with the CFD
provider.
You are effectively 'leveraging' or 'gearing' your investment, being
offered credit with which to buy CFDs.
But it is this high level of gearing that makes CFDs particularly
risky, and therefore unsuitable for any private investor who does not
understand the risks or cannot afford to lose his or her investment. In
effect, you can double or lose your money by just a 20% move in the
underlying stock or index, depending if your call on whether they would go
up or down was right or wrong.
Even the brokers themselves admit that it is a market strictly for risk
capital.
Financing
Since the CFD provider is effectively lending you money, you get
charged financing costs for CFD share positions kept open overnight.
Typically you get charged interest on the 'unmargined' portion of your
position. In other words if you put £50 down for a £1,000 trade, you'd get
charged (small) costs on the remaining £1,950.
However if you have 'sold' or 'gone short' a CFD, the company will pay
you interest.
While conventional Stock trading remains the most common form of
investment, new methods of trading stocks and other financial
instruments on a short term basis, like the C FD, are more cost
efficient.
The CFD or "Contract for Difference" is one of the most innovative
financial instruments available for the stock trader. CFD's have
revolutionised trading in the UK, where more than 20% of the total stock
market trading volume is undertaken through the use of CFDs.
In practical terms, investing in stocks through CFDs offers the active
investor the same opportunities for investing and profiting from stocks
as and when trading stocks in the traditional manner. However trading in
stocks using CFDs offers the active investor some very unique and
considerable advantages.
ADVANTAGES
Short Selling
Selling the market short is simple when using CFDs. No concerns about
borrowing stock or paying financing costs for borrowed shares, makes the
process very simple to adopt when wishing to go short of the market.
Simply sell then buy back the CFD at any time in the future.
Paper-less Trading
Unlike many international stock markets which still require a paper
trail for the investors to account for any holding of stocks quoted on
the relevant stock exchange, trading CFDs is entirely electronic and
requires no further administration (such as stock certificates, transfer
forms, custodian fees etc.)
Gearing
CFDs provide leverage of up to 5 times under normal conditions. This is
by no means a necessity for all investors, but for aggressive, risk
willing investors this feature is probably the most important advantage
offered by using the CFD.
Portfolio Hedging
Hedging an existing portfolio is another popular use for CFDs. During
periods with falling stock markets and/or volatile market conditions, an
investor can quickly and efficiently hedge the potential risks to an
existing stock portfolio by selling the equivalent positions using CFDs
for a short or long period. This will secure effective protection for
stock investments at relatively little or no cost.
Many international markets on one single platform,
but just one pricing model
When trading CFDs with Pacific Continental Securities (UK) Ltd, clients
can trade in all major US and European stocks on one platform. Our
traders will quote stock prices inclusive of dealing commissions,
thereby providing a net dealing price. No matter what market, we at
Pacific Continental Securities (UK) Ltd will provide the same tight
dealing spread and there are no extra custodian or exchange fees
payable, just a financing rate for any long CFD positions.
