How to trade CFDs

Trading using leverage

Using leverage is a key advantage of CFD trading, but needs to be fully understood to avoid potential pitfalls. To illustrate this, let’s go through a detailed example showing a Share CFD trade using leverage.

Let’s say BHP shares are currently trading at $6.161 and you want to buy 1000 shares. If you buy from a broker, ignoring commission, you will pay 1000 x $6.161 = $6161.

If you buy 1000 BHP shares as a CFD, you will be able to use leverage and only put up a fraction of the full value as an initial margin. For a major share like BHP, the margin rate may be as low as 5%. So to buy 1000 shares as a CFD you would pay 1000 x $6.161 x 0.05 = $308.05.

You can clearly see how using leverage significantly reduced your capital outlay ($308.05 instead of $6161).

Despite this, both trades offer you the same exposure – if BHP's share price goes up or down, your profit or loss will be exactly the same regardless of whether you bought the shares outright or simply traded them as a CFD.

Say HSBC drops to 582.5p and you decide to cut your losses and trade out of your position. If you had physically purchased the 1000 shares, you would sell them at 582.5p and get back 1000 x 582.5p = $5825. This would mean a loss of $6161 - $5825 = $336.

If you had bought 1000 shares as a CFD, your loss is calculated by taking the difference between the opening and closing value of the share, and multiplying by the number of contracts you bought. In this case, HSBC dropped from 616.1p to 582.5p, a loss of 33.6p. 1000 x 33.6p = $336.

The overall loss is the same in both cases, although with the CFD it exceeds your initial margin. So you can see that it’s important to think in terms of the full value of your position, rather than just the margin you have put down.

Margin rates and slippage factors can vary, dependent on the regulatory rules governing the country in which your account is based.

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Margin requirements

To open a position with IG you only need to put up a fraction of the full contract size. This is known as the initial margin.

  • Shares: more than 7000 shares from only 5% (including majors such as Vodafone and BHP)
  • Forex: from just 0.5% of the full contract value
  • Indices: variable; $300 per contract on the ASX 200, for example

CFDs are a leveraged product and can result in losses that exceed your initial deposit.

Margin rates and slippage factors can vary, dependent on the regulatory rules governing the country in which your account is based.

Margin with guaranteed stops

When you place a guaranteed stop on a position the margin requirement is equivalent to the total risk. This is calculated as your exposure per unit movement multiplied by the distance between the stop level and the opening level of the trade.

For example, let’s say we’re quoting the Germany 30 at 4702/4703 and you want to buy one contract with a guaranteed stop attached.

One contract of Germany 30 has the value of €25 per point movement and the premium charge for placing a guaranteed stop is three points. You therefore open your trade at 4706 (4703 + 3) and place a guaranteed stop 20 points away at 4686 (4706 – 20).

Your maximum risk is therefore 25 x 20 = €500, and because you have placed a guaranteed stop this is also the margin you will be required to have available in your account to place the trade.

Without placing a guaranteed stop, the initial margin requirement for one contract would have been €875.

Margin rates and slippage factors can vary, dependent on the regulatory rules governing the country in which your account is based.

When you place a guaranteed stop on a position the margin requirement is equivalent to the total risk.

Margin with non-guaranteed stops

Because a non-guaranteed stop is subject to slippage, the margin requirement is sometimes greater than for a position opened with a guaranteed stop. This depends on the relevant market and / or your stop distance. The margin requirement for a position with a non-guaranteed stop comprises two parts:

Risk margin: exposure per point movement x stop distance

Slippage margin: slippage factor x normal initial margin

The normal initial margin is the margin that would be required on the contract if no stop was placed at all. The slippage factor is a percentage that is applied individually to various markets and usually ranges from 20% to 30%.

Margin rates and slippage factors can vary, dependent on the regulatory rules governing the country in which your account is based.

Non-guaranteed stop example

Let’s say you want to go long 1000 shares of Citigroup at $28. Because Citigroup is margined at 10%, the normal initial margin would be 10% x 1000 shares x $28 = $2800.

However, you want to place a non-guaranteed stop at $27, which will reduce your margin requirement. To calculate this new margin requirement, first we calculate the risk margin:

For 1000 shares, the exposure per point movement is $10 (i.e. 1000 x $28 – 1000 x $27.99 = $28,000 - $27,990 = $10).

You’ve selected a stop distance of 100 ($28.00 - $27.00). Therefore, your risk margin would be $10 x 100 = $1000.

To this you must add the slippage margin:

Citigroup has a slippage factor of 30%, and we saw earlier that the normal initial margin for 1000 Citigroup shares is $2800.

Therefore, slippage margin is 30% x 2800 = $840.

Your total margin requirement, therefore, would be $1000 + $840 = $1840, compared to the $2800 you would have had to provide without a non-guaranteed stop in place.

The margin requirement for a position with a non-guaranteed stop is calculated as risk deposit plus slippage deposit.