CFDs on Shares
CFDs are perhaps most commonly traded on shares and the share markets, with share dealing providing a tried and tested market in which investors can profit. With a diversity of companies and sectors to choose from, traders use CFDs to trade shares in larger volumes than would otherwise be possible, as a result of the inherent leverage in CFD transactions. For a notional margin requirement of say 5%, traders can gear up transactions to 20 times the size of their available capital, to enable much more significant returns over much shorter periods of time. CFDs track share prices relatively closely, and it is normally the case than 1 contract is equal to 1 share, so the main benefit of using CFDs as opposed to the shares directly is the sheer power of the leverage afforded by CFD margin trading terms.
Furthermore, trading through CFDs saves on stamp duty, a tax payable on some share transactions. In addition to being more cost-effective, this also makes CFDs more tax efficient for profitable traders.
CFDs on Indices
Another popular area in which CFDs are traded is on indices, commonly including the global stock markets. Some brokers even offer markets on interest rate pairings and other such markets, relying only on the index as a basis on which to write up CFDs. This is because the CFD needs to be linked to a price tracking market, and markets can be made up from a range of different bases. So, in the case of a market like the FTSE 100, a FTSE 100 CFD isn’t linked to any asset, but instead linked to the index price of the FTSE, which would otherwise be impossible to trade on in a single transaction.
CFDs are popular means of trading on markets because they provide a neat solution to a problem for many investors: how to invest in a market as an overall reflection of economic performance when there is no asset to trade. This means traders can take positions in markets like the FTSE or the DAX on the strength of economic and fiscal data and profit from their speculation on market movements.
CFDs on Commodities
CFDs are also traded on commodities across a range of different commodities markets. From oil to steel, from wheat to soya, the range of commodities on offer gives traders access to a host of alternative, often highly volatile markets for speculation and investment purposes. When CFDs are introduced into the equation, the outcome is even greater risk/reward potential on already volatile markets, through the artificially inflated transaction size delivered by the leverage. That’s not to mention, of course, the practicalities of trading in commodities otherwise.
Say, for example, coffee prices rise 5% on the day following supply fears, and you want to expose some of your capital to the coffee market to take advantage of this rise. Your options at this stage are fairly limited. Of course, you can actually buy a quantity of coffee beans and pay for logistics and warehousing in addition to the risks of holding stock, or you can invest through a derivative instrument which is tagged to coffee prices, like a futures contract or a CFD. The CFD takes hold as a flexible, highly leveraged option, solving both the practical issues of commodity investment and delivering a substantially higher proportional return.
CFDs on Currency
Similarly, currency fluctuations are also a common basis for CFD trading, providing markets through which traders can speculate on the economic strength and policy of the world’s global economies. Highly volatile in nature, currency rates fluctuate throughout the day and night, and provide an excellent, if not high-risk, environment in which traders can make a profit. With CFDs, this effect is amplified at relatively low cost to deliver positions often several times larger than capital resources could allow, capitalising much more heavily on the markets moving in favour of a trader’s position.
CFDs on currency are heavily traded, as indeed are CFDs across other asset classes and indices. In truth, CFDs now account for a significant proportion of UK financial trade, and the opportunities they can present for profiting are vast. Let’s now turn our attention to how CFDs actually work – the nuts and bolts of the CFD transaction – to get a better understanding of how you can start to trade CFDs profitably.