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CFD Education

History of CFDs

CFD trading has been available to retail clients since the late 1990's and they were quickly marketed by a number of UK derivative providers with investors keen to get involved. CFD providers quickly expanded their range of markets available to trade from initially just the London stock exchange to Dow Jones, Nasdaq, S&P500, DAX, ASX200 and many more. The simplicity of CFD trading and the rise of the internet made it easy for providers to offer clients state of the art trading platforms to execute trades and monitor the markets without the need of an actual broker thus reducing costs to the client and raising the profit margins of the providers.

CFD providers have now expanded overseas with Australia being introduced to this innovative market in 2002 and retail markets opening up in Europe and Canada.

One of the latest developments in CFDs has occurred in Australia with the first regulated CFD exchange opening its doors in November 2007.

What is a CFD?
In simple terms a Contract for Difference (CFD) is 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 within the contract.

There are always two parties in a CFD transaction, the long party and the short party. A client who opens a position by buying a CFD is the long party and a client who opens a contract by selling a CFD is the short party.

How are CFDs traded?
A CFD allows you to take a position in a stock without buying or selling the stock itself. The contract value is defined as the number of shares multiplied by the share price. The performance of the CFD is determined by the movement in the underlying share price.

When you close out the position, your profit/loss comes from the difference between the opening and closing contract values, hence "Contract for Difference".

As you do not buy or sell the underlying stock you are not obliged to acquire or deliver the physical shares.

Why trade CFDs rather than physical shares?

Margin flexibility: CFDs are traded on margin which means you can take positions in the market offering a higher exposure than previously available.
Long or Short: CFDs give you the ability to buy the stock if you are bullish about the market or sell the stock if you feel the market will move downwards.
Risk Management: The ability to "go short" means that you can hedge your stock positions therefore reducing your overall stock market risk.
No Value Date: The contract has no settlement date and becomes effective from the date the order is placed.
No stamp duty applicable on UK purchases and no GST added to fees and charges for Australian purchases.

How do CFDs work in practice?
You put down a deposit with your broker in a client account and this is used as collateral to allow you to trade. The level of "gearing" you can apply to the margin will determine the value of the trade and is usually determined by the individual stock.

The trade is executed in the same way as for stocks. The account is valued "real" time and when the position is closed, the profit or loss is returned along with the initial margin.

Other costs

Each trade will accrue a commission charge, normally charged as a percentage of the trade value. Also, as your provider is funding on average 90% of the contract value, long positions will attract a funding (interest) charge and in turn short positions usually receive interest credited calculated. The funding charge is normally a small percentage above the current base rate for the country the CFD is traded on, for short positions this figure is a small percentage below the base rate.

Dividends

Despite the fact that you do not take physical delivery of the stock, dividends are still applicable. On long positions you will usually receive 100% of the dividend and on short positions you will pay out 100% of the dividend. Dividends on CFD positions are normally paid on the ex-dividend date rather than the payable date as with stocks.

Direct Market Access (DMA)

If you are looking to trade or scalp the market aggressively it is essential to have direct access to the Order Book. DMA trading offers exact exchange prices, and allows traders to see market depth. This helps to give a clearer picture of the market for the stock and avoids the market maker situation.

DMA trading is usually available on the leading exchanges but clients may have to pay additional costs such as exchange fees and sometimes slightly higher commissions.