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Introduction to CFDs

Contracts for Difference (CFDs) have caught the imagination of the active private investor since their introduction to the retail marketplace in the early 2000s. Prior to this they were used mainly by institutions seeking to extract the performance of a stock rather than owning the actual share itself.

CFDs are a cost effective, flexible and tax efficient way to back your favourite shares or markets. You can use them to make a profit in rising or falling markets, to trade on margin (i.e. without having to put up the full consideration of a trade), and to gain low cost exposure to equity movements, as there is no stamp duty payable on CFD transactions. These features make them ideal trading instruments.

In simple terms, CFDs replicate traditional share trading. A CFD is a contract to exchange the difference between the opening price and the closing price of an instrument at the close of the contract. For example, if a share is trading at 160p when you buy, and then 180p when you sell, then you will make 20p. And if you buy 1 CFD at 160p and then sell at 180p, you will also make 20p. It is estimated that 20% of the UK equity market turnover is based on paper contracts as opposed to the actual transfer of shares.

In most regards, CFDs work in the same way as owning the underlying securities:

  • They allow you to get an economic exposure to market movements.
  • Your open positions are valued every night at the close of market prices.
  • Profits or losses are credited / debited to your account each day.
  • Adjustments for dividends, bonus issues, etc in respect of the underlying security are also applied to your account should they occur.

CFDs are offered on thousands of instruments such as oil, gold, dollars, the FTSE, international shares like Google and Nokia, and many, many more. Typically it is possible to trade any UK stocks with a market capitalisation over 50M (including AIM), any European stocks with a market capitalisation over 500 and US stocks with a market capitalisation over $500 as well as all major global indices like the S&P500, futures, commodities, currencies like the yen or the dollar and more.

This guide will introduce you to CFDs and how you can use them to your advantage. You will learn the basic differences between CFDs and shares and the advantages and disadvantages of CFDs. You will be introduced to new terms, view examples and learn how to get started.

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