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Contracts For Difference

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Presentation on theme: "Contracts For Difference"— Presentation transcript:

1 Contracts For Difference

2 What is a CFD? An agreement: between two parties to exchange, at the close of the contract, the difference between the opening and closing price of the contract multiplied by the number of shares specified with the contract.

3 Parties in a CFD transaction There are always two parties: The LONG party An investor who opens a position by BUYING a CFD The SHORT party An investor who opens a contract by SELLING a CFD

4 Why CFDs v. Physical Shares? Margin Flexibility (CFDs are traded on margin) i. You can take positions in the market 5 times greater value than your normal cash trade, or … ii. You can trade your normal size and deposit only 20% of the value as initial margin Long or short i. BUY stock (go LONG), or … ii. SELL stock (go SHORT) depending on your market sentiment

5 Why CFDs v. Physical Shares? No stamp duty As you are not buying physical shares, you are not liable for stamp duty (under current UK legislation) = save ½% per trade

6 What stocks can I trade? CFDs can be traded on all stocks with a market capitalisation above: UK = £50 million market cap European = 100 million market cap US = $1 billion market cap

7 How do CFDs work? Normal Share Trading: BUYSELL 10,000 shares CFD Share Trading: BUYSELL 10,000 shares OPEN TRADE CLOSE TRADE OPEN TRADE OR OPEN TRADE … open trade on buy side or sell side LONGSHORT

8 Dividends Dividends still apply even though you do not take physical delivery

9 How does Margin work? Account value £100,000Stage 1 Open a £50,000 trade (requires £10,000 as a 20% good-faith deposit) Stage 2 Stage 3 Left to trade: £90,000 Initial Margin £10,000 Variation Margin £ profit/ loss real-time Stage 4Close position - Profit/ loss returned with initial margin £90,000 + £10,000 Initial Margin +/- £ profit/ loss

10 Costs Commission Every trade accrues a commission charge Interest As your broker is funding 80% of the contract value, you pay or receive a minimal interest charge i. Long positions – you pay a spread over LIBOR on the 80% ii. Short positions – you receive a spread under LIBID on the 80%

11 CFD Trading Rules Trade with money you can afford to lose Do NOT over leverage Risk Management – make sure trades are at least 2:1 in your favour Use STOP LOSSES – limit your downside, only moving a stop loss to REDUCE risk Know your entry AND exit levels before executing a trade DISCIPLINE – develop out a system that works for you and stick to it

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