What are CFDs
Contracts for difference (CFDs), like spread bets, are an accessible way to trade on the prices of financial instruments such as shares, indices and commodities.
Unlike buying shares, when trading CFDs you do not physically own the underlying instrument you are buying or selling and therefore do not have to pay the associated costs of using a stockbroker such as account management fees, commissions and stamp duty. Tax treatment depends on individual circumstances and may change in the future.
CFDs allow you to trade on whether the price of a financial instrument is likely to go up in value (strengthen) or go down (weaken). Your profit or loss is determined by the difference you buy at and the price you sell at. This gives you the opportunity to potentially profit from a market whether it is rising or falling.
For example, imagine a major oil company has just forecast a record profit and you think the price will go up. You decide to buy 1000 CFDs at 1950 pence. If the price moved up, say from 1950 to 1990 pence, you would have made a profit of 40 pence per CFD owned. With 1000 CFDs, that would equate to £400. However, if the price dropped by 40 pence, you would lose £400 instead. For a more detailed example of a CFD trade visit our CFD trading example.
- Buying a rising market
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If you buy a financial instrument that you believe will rise in value, and in due course your prediction is correct, you can sell the instrument for a profit. However if you are incorrect and the value falls, you will make a loss.
- Selling a falling financial market
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If you sell a financial instrument that you believe will fall in value, and in due course your prediction is correct, you can buy the instrument back at a lower price, for a profit. If you are incorrect and the value rises, you make a loss.
- Margin trading
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CFDs are a leveraged product which means that you are only required to deposit a fraction of the overall value of the trade. Typically, margins with CMC Markets vary between 1% and 15%. Margin enables you to magnify your return on investment. However, losses will also be magnified so it is advisable to use one of the free risk management tools such as a stop loss or limit order that CMC Markets provides to help take control of your risk.
- The spread
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As with prices of all financial instruments, CFD prices are quoted in pairs. The bid or ‘sell’ price is quoted first and the offer or ‘buy’ price is quoted second. The spread is the difference between the bid and offer. If you think the price is going to go down, you use the sell price. If you think it will go up, you use the buy price. To close out your position, you use the opposite price to the one you used when you opened it.
For example, If you were viewing the UK100 price, it might look like the example to the right. Buy at 4502 if you think UK100 will rise in value. Sell at 4500 if you think UK100 will fall in value.
With CFD trading your profit or loss is determined by the difference between the buy price and the sell price of the financial instrument that you are trading. Imagine this scenario about fictional oil company called North Sea Oil PLC (NSO):