What are Contracts for Difference (CFDs)?
A Contract for Difference, or CFD, “An agreement
between two parties to exchange, at the close of the contract, the
difference between the opening price and the closing price of the
contract.”
CFDs are a derivative product designed for active traders who
want to leverage their investments. This leverage gives investors
the potential to make greater profits (or losses) for the same
initial investment.
CFDs can be traded ‘long’ or ‘short’ to speculate on either
rising or falling markets. They are available on individual
equities, market sectors, market indices, currencies and
commodities on both UK and International markets.
Why Trade CFDs?
CFDs offer a number of benefits to active traders who can
afford to place a portion of their assets into high-risk
investments in exchange for potentially high returns.
Flexibility
Contracts for Difference offer access to a wide
range of financial instruments from a single account. With TD
Waterhouse CFDs you can trade on individual shares, indices,
commodities and currencies on both UK and International markets.
They are quick and easy to trade online and by phone, and can be
used to back an investment to go either up or down.
A Contract for Difference does not confer
ownership of the underlying investment, just access to the price
performance including any dividend or corporate action equivalent.
This means that because CFD traders do not hold the
physical asset, any benefits associated with direct share
ownership, such as shareholder voting rights or an invitation to
the company’s AGM, are not available
Tax advantage
As CFD trades do not confer ownership rights these trades are
not subject to UK Stamp Duty. Saving CFD trades therefore
save the current 0.5% charge levied on share purchases. Tax
laws may change.
Leverage
Contracts for Difference are a leveraged
investment, which means that the initial deposit required to place
a trade is only a fraction of the value of the total position. The
initial deposit is, in effect, a down payment on any loss that may
be incurred. This leverage gives CFD investors the potential to
make greater profits for the same initial investment. Conversely
leverage also increases the potential for losses, which can quickly
exceed the initial deposit. When you hold an open position
with a CFD, the minimum deposit level must be maintained at
all times, and losses will give rise to Margin calls.
Instant Execution
TD Waterhouse CFDs offers instant execution in standard size
or below as we make firm prices. Larger orders may be delayed as TD
Waterhouse CFDs may hedge in the underlying instrument.
Closing Positions
You can close your position at any time during TD Waterhouse
CFDs opening hours.
Stop Losses to limit your risks
Where available you can use Stop Losses to automatically close
out a position if it turns against you, and thus limit your
downside.
Hedge your Bets
You can use CFDs to reduce the risk of unexpected market
movements. For example, you may have a long term share portfolio
that you know you want to keep hold of, but you are worried that it
may lose value in the short term because you think markets are
heading down. You can take out a CFD that will help mitigate any
short term loss, but at the same time may assist you to make a long
term gain.
Tax efficient trading
If you have a holding of physical shares you can sell CFDs
against this holding without crystallising a potentially taxable
gain. This enables you to control the time at which you crystallise
capital gains or losses to manage your tax liability.
Pairs trading
If you think that one stock is undervalued compared to
another, you can use CFDs to go long (buy) one company and go short
(sell) the other. For example BP compared to Royal Dutch*,
even though they run similar businesses, you can use CFDs to go
long (buy) one company and go short (sell) the other. This can be a
useful trading strategy for the more active
CFD investor.
* TD Waterhouse CFDs may hold positions in BP and/or Royal
Dutch in the ordinary course of business.
Services to meet your needs
We know that one size rarely fits all, so we offer everything
from low deposit requirements and extended trading hours in
selected markets for active traders, through to small stakes and
stop losses.
Please note that whereas there are many advantages of trading
CFDs there are also risks. Since CFDs is a leveraged product, you
can lose more than your initial deposit. You should ensure that you
are aware of all the risks as this product is not suitable for
everyone.
Comparison of Conventional Share Trading and CFD
Trading for
ABC Plc
CFDs offer a very cost efficient alternative to conventional
share trading, as illustrated below.
Opening Trade
| |
Share Trade |
CFD Trade |
| Price of ABC Plc |
861p |
861p |
| Number of Shares |
2,000 |
2,000 |
| Value of Shares |
£17,220.00 |
£17,220.00 |
| Stamp Duty |
£86.10 (0.5%) |
£0.00 |
| Commission |
£15.00 |
£34.44 (0.20%) |
| Margin
Requirement (10%) |
0 |
£1,722.00 |
| Initial Investment |
£17,321.10 |
£1,756.44 |
Closing Trade
| |
Share Trade |
CFD Trade |
| Price of ABC Plc |
892p |
892p |
| Number of
Shares |
2,000 |
2,000 |
| Value of Shares |
£17,840.00 |
£17,840.00 |
| Commission |
£15.00 |
£35.68 (0.20%) |
| Closing Value of Shares |
£17,840.00 |
£17,840.00 |
| Opening Value of Shares |
£17,220.00 |
£17,220.00 |
| Profit on Trade |
£620.00 |
£620.00 |
| Stamp
Duty |
(£86.10) |
£0.00 |
| Total Commission |
(30.00) |
(70.12) |
| Financing* |
£0.00 |
(£9.90) |
| Overall Profit on Trade |
£503.90 |
£539.98 |
The return on initial investment from trading
conventional shares is 2.9%.
This can be compared to the return of 30.7% using
Contracts for Difference with TD Waterhouse CFDs.
