By Kim Dawkins

There are so many ways of trading that deciding between them can be challenging. CFDs are a popular method of trading.

Contracts for Difference (CFDs) have been in use since the early 1990s. CFD is where two parties (a buyer and a seller) agree to exchange the difference between the opening and closing price of a contract. It isn’t necessarily a prerogative of the trading room floor. Last year the Neart na Gaoithe offshore wind farm struck a deal with the National Grid. They were awarded a 15 year CFD subsidy meaning that their production of electricity had a strike price linked to the rate of inflation.

Considering how political events can affect the commodities on which CFD trading is based is as good a way as any of explaining the concept.

Let us suppose that our trader looking at the US presidential elections exit poll considers that Donald Trump will win. They find a company Acme Products which has 90% of its export trade with the USA. The trader decides that this is going to negatively impact on the share price of the company and so sells 1000 share CFDs at the current price of 1430p.

Three or four things can happen.

  1. The exit poll is correct. Trump wins. Our trader buys the shares back at the new buy price which is 60p down with a gain of £600.
  2. The exit poll is correct. Trump wins but surprisingly the share price rises to 1440p. The trader opines that the price will continue to rise and so buys back the shares at this price, closing the position. There is a resultant loss of 10p per share and the trader is down £100.
  3. The exit poll is wrong and Bill Clinton is the new First Lady, sorry Gentleman. The share price rises to 1500p resulting in a loss of 70p per share. Our trader has just lost £700.
  4. The exit poll is wrong and Hillary Clinton becomes the first woman president. The FBI releases some incriminating emails and the share price plummets to 1320p. Victory is grabbed from the jaws of defeat and our trader gains £1,100.

So what is the difference between CFD trading and trading in ordinary shares?

  • CFD allows you to trade on both rising and falling share prices thus benefiting from fluctuating markets. If you trade in ordinary shares and they fall you lose money.
  • CFDs can be used to hedge a portfolio from losses. Despite some of the shares in your portfolio losing value if you have predicted this loss using a CFD you can recoup some or all, of your loss.
  • CFDs can be tax efficient as in certain instances CFD losses may be used to offset Capital Gains Tax obligations.
  • CFDs are traded on leverage therefore you can speculate a fraction of the share price.
  • CFDs are derivatives which means you don’t have ownership of the actual underlying asset. This means that there is no stamp duty due – a saving of 0.5%.

How does our novice trader then work their way through this labyrinth? A reliable broker, such as CMC Markets has a wealth of experience in working with different market conditions. A broker can guide you to what is the best product for your individual needs and circumstances. A reputable, experienced broker can use that experience to provide a continuity of advice which is built on a knowledge of both the client and the market.

A brokerage service doesn’t entirely remove the risk from CFD trading but providing resources such as trading charts and other methods of research can provide some basis for a more assured trading.

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