How spread betting and CFD trading work
How a CFD trade works
Now that we know you can trade on a financial asset such as silver using a CFD, let's take a look at how you might go about taking a position.
Say you think the price of silver will rise, so you decide to 'buy' five CFD contracts at 1653.
A week later the price of silver is quoted by your provider at 1683/1686, and you think it's time to 'sell' and close your position.
Your profit or loss is calculated as the number of contracts you've traded, multiplied by the value of the contract per point of movement, multiplied by the difference in points between the opening and closing prices.
So in the scenario above you would have made $7500:
Five contracts x $50 x 30 points = $7500
You might also need to factor in commission or other charges, as we'll explain shortly.
The number of contracts you choose to trade is up to you, but always remember that the value of one contract will vary from market to market and may be denominated in different currencies. For example, one contract of the FTSE might be worth £10 per point of movement, while one Nikkei 225 contract might be worth just $5 (or around £3) per point.
When trading share CFDs, the contract size is usually equivalent to one share of the company you're trading. So if you wanted to buy the equivalent of 1000 shares of Vodafone, you would simply buy 1000 Vodafone share CFDs.
Question
Banking Company B is offered by a CFD provider at 565/567 - the equivalent of a bid price of £5.65 and an offer price of £5.67 in the underlying market.You think the price of Banking Company B will rise, so you decide to 'buy' 10,000 shares as a CFD. Later that week Banking Company B is offered at 577/579. You decide to 'sell' and close your position. Ignoring any commission or other charges for now, how much profit or loss have you made?
Correct
Incorrect
The price of Banking Company B rose by 10p per share between opening and closing, so you made 10,000 x 10p = £1000. To calculate your net profit, you would need to deduct any other charges, like commission or overnight funding. We explain these below and in the next section.Overnight funding charges
Just like when you open a daily spread bet, when trading CFDs your provider will generally charge you a fee for holding the position overnight (unless you're trading futures, forwards and digital 100s). These are called financing costs or funding charges, and reflect the cost of borrowing or lending the underlying asset. So, for each day your position remains open, you'll accrue additional costs.
Why trade CFDs?
Many of the arguments for trading CFDs in lieu of conventional trading are the same as for spread betting. With CFDs you can:
- Go long or short
- Trade using leverage (ie trade on margin)
- Access some markets 24 hours a day
Did you know?
Of course, the same risks apply to CFDs as to spread betting, and it's important to remember that your losses can be higher than the deposits you make to open your positions.
Lesson summary
- Profit/loss = number of contracts traded x value of the contract per point of movement x difference in points between opening and closing prices
- Funding charges usually apply if you hold a CFD open overnight
- If the money held on your account drops below the level needed to cover your positions, you'll receive a margin call
- CFDs have many of the same benefits as spread betting, as well as the same risks
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