Contracts for difference (CFDs) provide a flexible way to trade on the price movements of thousands of global financial products such as shares, indices, commodities, currencies and treasuries.
When you trade CFDs, you don’t buy or sell the underlying asset (e.g. a physical share), you buy or sell a number of units, depending on whether you think a product’s price will go up or down. For every point the price moves in your favour, you gain multiples of the number of units you have bought or sold. For every point the price moves against you, you will make a loss. Please remember this loss can exceed your deposits.
What is margin and leverage?
CFDs are a leveraged product, which means that you only need to deposit a small percentage of the full value of the trade in order to open a position. This is called ‘trading on margin’. While trading on margin allows you to magnify your returns, losses will also be magnified as they are based on the full value of the position, meaning you could lose more than any capital deposited.
What are the costs of CFD trading?
Spread: As in all markets, when trading CFDs you must pay the spread, which is the difference between the buy and sell price. You enter a buy trade using the buy price quoted and exit using the sell price, so the narrower the spread, the less you need the price to move in your favour before you start making a profit or loss.
Holding costs: At the end of each trading day (17:00 New York time), any positions open in your account may be subject to a charge called a “holding cost”. The holding cost can be positive or negative depending on the direction of your position and the applicable holding rate.
Market data fees: To trade or view our price data for share CFDs you must activate the relevant market data subscription for which a fee will be charged. Please click here to view data fees.
Commissions: (only applicable for shares): You must also pay a separate commission charge when you trade share CFDs. Commissions on US and Canadian shares on the CMC Markets CFD trading platform start from 1 cent a unit, minimum $8 in the currency of the share.
Example 1 – Opening Trade
|A 1,000 unit trade on US Company ABC at a price of $10 would incur a commission charge of $10 to enter the trade:|
|1000 units x 1 cent a unit||= $10.00 USD|
Example 2 – Opening Trade
|A 500 unit trade on US Company ABC at a price of $10 would incur the minimum commission charge of $8 to enter the trade:|
|500 units x 1 cent a unit||=
As this is less than the minimum commission charge for US share CFDs, the minimum commission charge of $8 would be applied to this trade.)
Please note: CFD trades incur a commission charge when the trade is opened as well as when it is closed. The above calculation can be applied for a closing trade, the only difference is that you use the exit price rather than the entry price.
Example of a CFD trade
Buying a company share in a rising market
In this example, US Company ABC is trading at 9.98 / 10.00 (where $9.98 is the sell price and $10.00 is the buy price). The spread is 2 cents.
You think the company’s price is going to go up so you decide to buy 1,000 CFDs, or ‘units’ at $10.00. A separate commission charge of $10 would be applied when you open the trade (1,000 units x 1 cent a unit = $10).
Company ABC has a margin rate of 20%, which means you only have to deposit 20% of the total value of the trade as position margin. Therefore, in this example your position margin will be $2,000 (1,000 units x $10.00 = $10,000 x 20%).
Remember that if the price moves against you, it is possible to lose more than your margin of $2,000, as losses will be based on the full value of the position.
Outcome A: a profitable trade
Your prediction was correct and the price rises over the next week to 11.00 / 11.02. You decide to close your buy trade by selling at $11.00 (the current sell price). Remember, commission is charged when you exit a trade too, so a charge of $10 would be applied when you close the trade, (1,000 units x 1 cent a unit = $10).
The price has moved $1.00 in your favour, from $10.00 (the initial buy price) to $11.00 (the current sell price). Multiply this by the number of units you bought (1,000) to calculate your profit of $1,000, then subtract the total commission charge ($10 at entry + $10 at exit = $20) which results in a total profit of $980.
Outcome B: a losing trade
Unfortunately, your prediction was wrong and the price of Company ABC drops over the next week to 9.50 / 9.52. You think the price is likely to continue dropping so, to limit your losses, you decide to sell at $9.50 (the current sell price) to close the trade. As commission is charged when you exit a trade too, a charge of $10 would apply (1,000 units x 1 cent a unit = $10).
The price has moved $0.50 against you, from $10.00 (the initial buy price) to $9.50 (the current sell price). Multiply this by the number of units you bought (1,000) to calculate your loss of $500, plus the total commission charge ($10 at entry + $10 at exit = $20) which results in a total loss of $520.
Short-selling in a falling market
If you decide to sell a product that you believe will fall in value and your prediction turns out to be correct, you can buy the product back at a lower price at a profit. If you are incorrect and the value rises, you will make a loss. This loss can exceed your deposits.
Hedge your physical portfolio
If you have already invested in an existing portfolio of physical shares with another broker and you think they may lose some of their value over the short term, you can hedge your physical shares using CFDs. By short selling the same shares in CFDs, you can try and make a profit from the short-term downtrend to offset any loss from your existing portfolio.
For example, say you hold $5,000 worth of physical ABC Corp shares in your portfolio; you could short sell the equivalent value of ABC Corp with CFDs. Then, if ABC Corp’s share prices fall in the underlying market, the loss in value of your physical share portfolio could potentially be offset by the profit made on your short sell CFD trade. You could then close out of your CFD trade to secure your profits as the short-term downtrend comes to an end and the value of your physical shares starts to rise again.
Using CFDs to hedge physical share portfolios is a popular strategy for many investors, especially in volatile markets.
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