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An introduction to CFD (Contracts for Difference) trading and how it works, featuring examples and reasons to trade CFDs. We also discuss the related pricing and funding requirements.
|Introduction to CFDs||Trading CFDs||Pricing and funding|
|What is a CFD?How does CFD trading work?||Why trade CFDs?CFD marketsRisks of CFD trading||SpreadsCommissionMarginFunding and interestCurrency conversionOther fees|
A CFD (Contract for Difference) is an agreement to exchange the difference in the value of an asset from the time the contract is opened until the time at which it is closed.
With a CFD, you never actually own the asset or instrument you’ve chosen to trade, but you can still benefit if the market moves in your favour. This is because a CFD is a derivative product which has a value based on an underlying asset.
By trading CFDs, you can potentially profit whether a market moves up or down.
If you believe an asset’s price is going to rise, you open a buy position (known as ‘going long’). If you think the asset’s price is going to fall, you open a sell position (known as ‘going short’). The performance of the market governs not just whether you make a profit or loss, but also how much.
So let’s say you think a particular market will rise, and you buy a CFD to trade it. Your profit will be greater the further the market rises, and your losses greater the further it declines. The same rule applies if you back a market to fall: you’ll make more the further the market drops, and lose more the further the market rises.
With IG you can trade CFDs on a huge range of markets, including shares, indices, commodities, foreign exchange and many more. Trading a share CFD, for example, is in many ways similar to traditional share trading, but with added advantages in convenience and cost. You can also trade markets such as stock indices through CFDs, which are not available to trade directly.
CFDs are a leveraged product and can result in losses that exceed your initial deposit.
The buy and sell price
We'll quote a two-way price on each market, just as you would see in the underlying market. This comprises the bid price (given first) and the offer price (given second). The difference between these prices is known as the spread. If you think a market is set to rise, you buy at the offer (higher) price; if you think the market is set to fall, you sell at the bid (lower) price.
For example, let's say we're currently quoting MTN at 19746/19750.
19746 is the bid price; the price at which you can sell
19750 is the offer price; the price at which you can buy
Calculating profit and loss
The number of shares or contracts you choose to trade is up to you, as long as you meet the minimum size we allow for any particular market. Bear in mind that the value of one contract varies for different markets.
Say, for example, that one contract of the South Africa 40 cash is worth R50 per point of movement in the underlying index. If you are long one contract on the SA 40, and the index rises by one point, that represents a R50 profit for you.
Similarly, say one full contract of EUR/USD is worth $10 per pip of movement in that currency pair. If you are short one contract on EUR/USD, and the price rises 1 pip, that represents a $10 loss for you.
Most CFD trades do not naturally expire. If you want to close out a position you simply place a trade of the same value in the opposite direction.
For example, let’s say you bought 100 shares of BP as a CFD. Unfortunately the price starts to fall, so you decide you’d rather close the position before you lose too much. To do this you would simply sell 100 BP shares as a CFD, realising whatever loss you have made.
There are some exceptions, however. We offer forward contracts on various commodities, for example, and these expire at specified dates in the future.
You don't have to wait until the expiry date to be released from your forward contract though – you can simply trade out at any given time before expiry. There is no additional funding required for forward contracts as the value is priced into the spread.
To find out more about funding charges, please see our pricing and funding section.