Contracts for Difference compared with Financial Spread Betting
A CFD (Contract for Difference) is an over the counter agreement between two parties to exchange the difference between the opening and the closing price of that contract at the close of the contract based on the underlying share multiplied by the number of shares specified in the contract. While it may sound slightly complicated it really is not at all. Major hedge funds have been making use of CFD in the UK stock market for just over ten years instead of regular sharedealing. They are many similar comparisions between CFD trading and spreadbetting in that both of them are margined products so you can gear yourself up or actually take a decision that is a multiple of your available funds.
If, for example, the margin on a firm youre interested in was 10%, establishing a position of £100,000 would only require a deposit of £10,000. Any running profits that you make can actually be used as margin to esablish new positions but any losses would have to be made good by reducing your position or by providing extra funds.
While stamp duty of 0.5% on all UK share purchases has in the opinion of some traders reduced the cost effectiveness of ‘day-trading’ traditional stocks and shares, both CFDs and spread betting are exempt and this has seemed to add to the appeal. CFDs are quite liable to capital gains tax whereas spread bets are tax free, but losses incurred from spread bets are gone for good while CFD losses can be offset against future profits for tax purposes. In the same way that you would buy shares, when you trade in CFDs the contract purchase is the same.. So if you wanted exposure to 1,000 shares in a company, youd have to sell 1,000 contracts at, say, 494p per contract rather than simply placing a £10 per point bet with spread betting to get a similar return.
A lot of CFD providers allow you to post orders anywhere within the bid offer spread whereas spread betting firms post their own two-way, take it or leave it price in the same way a bookie would. With CFD you are the price maker, which is why hedge funds incline to use CFDs rather than spread betting. CFDs do not enfold the costs of financing a position within the spread (as does spread betting) but charge those costs and commissions separately. With CFDs the charges and commissions involved in a trade are not part of the spread, which is the case with financial spread betting. Because of this, the CFD spread quote will constantly be very close to the underlying price of the share or commodity that you are following. CFD’s also mimic almost every aspect of actually owning the underlying share or market, so if you hold a position long enough, you receive the benefit of any dividends being paid on the underlying shares.
CFDs and spread betting have particular features that will appeal to different trading styles and there is no one best instrument to use. Although they should not be regarded as substitutes for long term investment or saving, as more people seek to take control of their financial destiny, theres been a growing realisation that going short is a legitimate means of trading in market thats become increasingly difficult to profit from in a traditional sense.
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