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I CFD I Features I Advantages I Examples I Advisory Services I FAQ’s |
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| Contracts for Difference (CFD) A Contract for Difference is exactly that, it is a contract with an entity (broker) to transfer the difference between the opening value and the closing value of an instrument, whether that instrument is an individual equity, a bond, an option and so on. CFD’s are the fastest growing instrument, simple, cheap and highly flexible. They will fit into any strategy that you currently use or wish to use. The best way to trade individual shares on margin is by using Contracts for Difference or CFD’s. Trading a CFD is very similar to normal share dealing. You deal at the cash price of the share, and pay a commission which is calculated as a percentage of the value of the transaction. However, you do not have to pay for the full value of the shares. Instead you put up a deposit (or margin), which is normally between 10% and 25% of the underlying contract value depending on the type of share and the time zone where you are located. Contracts for Difference (CFD’s) are mounting quickly in reputation and for the experienced investor they are proving an attractive means of gaining disclosure to the economic performance and cash flows of individual equities without the need to invest in the physical share. A CFD is a financial instrument linked to the underlying share price. Consequently, no rights are acquired or obligations incurred relating to the underlying share and, depending on your view of a company’s share price, you can buy (go long) or sell (go short). The ability to go short is one of the principal attractions of CFD’s as other methods of going short are both expensive and inconvenient. While your position remains open, your account is debited or credited to reflect interest and dividend adjustments. The direction of interest and dividend adjustments depends on whether you use a CFD to create a long or a short position. If you have a long position your account is debited to reflect interest adjustments and credited to reflect any dividends. The effect of these adjustments is to mirror the effect of buying shares in the normal way, where you no longer earn interest on the cost of the shares, but receive dividends instead. If you have a short position your account is credited with interest adjustments and debited to reflect any dividends. These adjustments mirror the effect of selling shares, where you earn interest on the proceeds of the sale, but cease to receive dividends. Traditionally, investors have always made profits by buying shares at a low price and selling them at a higher price. The share borrowing and lending facility (SBL) allows you to short the market by borrowing and returning shares but the accompanying administrative hassles often result in investors missing out on the 'right' price to sell. Contract for Difference (CFD) is a single trading tool for both long and short strategies with all the ease and convenience. CFD is a non-exchange traded product with shares as the underlying instrument. Unlike trade settlement for shares, each CFD contract has an expiry date of 30 calendar days although investors can choose to close out anytime before that. CFD prices are highly correlated to the price movements of the ready market. In addition, our CFD clients will also enjoy the same economic benefits such as share dividends, bonuses and stock splits. In order to understand what is actually a very simple product it is possible to look at CFD’s from 2 different angles: The first is to realize that CFD’s were designed to replicate conventional share trading and they do just that with a series of huge benefits. The second is to look at them compared to Spread Bets (another form of contract for difference) where all the charges are stripped out and billed separately as the costs are incurred rather than all up front at the opening of the trade. We prefer the former, for simplicities sake, and so look at CFD’s from the perspective of the person who currently trades or invests using a conventional broker. You will almost certainly be able to fit yourself and your style of trading into one of these and we have detailed below each one the benefits of CFD’s which are likely to be most important to you for your style of trading. Trading Style 1 - Active Traders: Active traders can be anyone from the big Day Trader, turning over tens of trades a day to the trader who takes the odd punt once or twice a week. Anyone falling into this category will benefit mostly from these three aspects of CFD’s: Massive Stamp Duty Savings and Fastest Execution: Because you are not physically buying or selling the stock, the broker is not slowed down by having to step into the market and execute that trade for you. This will mean that typical execution times are higher than with a conventional broker. Increased Liquidity: If the trades are not executed directly into the market then the CFD’s will increase the amount of stock available for everyone. It also means that if you are trading off charts then the fact that there may only be a few thousand shares available in the real market at your required price becomes much less of a problem. Trading Style 2 - Short Term Traders: The short-term trader is typically the person who is not looking to ‘job’ their position out from the moment they create it. Sometimes called ‘swing’ or ‘momentum’ traders these days, you are someone who takes advantage of value plays, news events or longer term chart trends, as such you have a slightly different series of requirements from the faster trader: Low Deposit Requirements: Freeing up huge amounts of capital for other trades or investments Low Commission Levels: Important for everyone really but this is probably the most significant cost for you. Use of Free Advisory Service: Several brokers run advisory services, which you can use to discuss your account with a broker and bounce ideas off of, as well as take ideas from. Trading style 3 – Investors This is the third type of CFD user and on the surface will appear to be the most unlikely, but it is important to recall that CFDs were originally created as a hedging tool for the investor and not the trader and is still used as such, along with other features which make it an invaluable tool for the investor to have at his disposal. Low Costs of Entry and Exit and Hedging Strategies: This allows a long term holding to be managed in a mature fashion through the market movements, which will occur over the time span of the holding. Selling short during a long down trend will allow you to profit from the fall as well as reduce your exposure and increasing your exposure in an up trend will create much higher returns. Tax Management: This is an area to be discussed with your broker and accountant but CFD’s are an important tool in the absence of Bed and Breakfasting in order to control your tax exposures and utilize your Government allowances. Contracts for Differences were developed to allow clients to receive all the benefits of owning a stock without having to physically own the stock itself. For example, instead of purchasing 1,000 shares of IBM from a stock broker, a client could instead buy a CFD on IBM on the Kerford trading platform. A $5 per share rise in the price of IBM would confer to the client a $5,000 profit, just as if he had purchased the actual shares that are traded on other platform. The major difference is that there are no fees and many of the inefficiencies of trading the underlying shares are eliminated. Kerford can therefore offer CFD’s with zero commissions and very attractive margin requirements. CFD’s have grown in popularity dramatically over the past few years, and we believe that this will increasingly be the preferred way to trade the financial markets. When buying and selling the performance of a share or Index through a CFD is almost identical to a physical equity trade financed by a loan. A client could borrow $10,000 from a bank to buy shares. The client would receive the returns from the shares, but would pay interest on the loan to the bank. CFD’s combine this process in a single transaction. However, if a CFD position is not carried overnight there will be no financing charge. The other major benefit of trading a CFD is the fact that the client can trade on margin. CFD trading means clients can trade a full portfolio of shares or indices without having to tie up large amounts of capital. You must maintain funds in your account to cover a minimum of 10% of your CFD exposure at all times. Contract for Difference is the only instrument that has the greatest impact over the market trading. Investors are less satisfied with building up portfolios over the long term, taking the ups and downs as they come. They are looking for instant gratification. One of the more common species of this is better known as the ‘day trader’. The day trader seeks to make returns from short-term movements in equities and will often trade relatively large sizes for only a few pence worth of profit. The most prolific day trader trades some 250 times a day which translates to one trade every two minutes. When one considers that there is relatively little activity in the first hour of the open market and over lunch, that’s someone who is trading almost constantly. The level of interest paid is the interest earned on money received from the market for the delivery of the stock plus the cost of borrowing that stock to deliver in the market. According to the bearish characteristics of the equity markets, the CFD’S are particularly a powerful tool. The fact remains, however, that most people still have a natural aversion to going short, or ‘selling things you don’t own’ as a client once said to me. CFD’s are designed to give you the same economic value as holding or being short of an equity position. CFD’s now offer gearing of ten times on the constituents of the main equity indices. On the buy side, because it’s a derivative, you don’t pay stamp duty. So what you end up with is a geared long/short equity derivative that is ideal for speculative trading in equities. The choice for the investor/ hedger/ speculator/ gambler is the return over a specific time period. If it is reasonably high over no more than a few months, then CFD’s will suit you well. Of course one is taking a higher risk profile than one’s stockbroker is likely to suggest. There are clearly many other benefits of CFD’s: short-term hedging of portfolios, for instance. But it’s no coincidence that CFD’s are the preferred day trader’s tool. Like all derivatives, CFD’s can be employed recklessly or sensibly. But CFD’s are first and foremost an incredibly powerful tool, once the domain of institutions only, now available to the retail market. For those people who have never used them before the advice is to start slowly and in relatively small size. Judicious use of ‘stops’ will also help to mitigate the potential sting in the tail of any position. The speculator’s foot is on the accelerator, happy journey or speeding fine: that’s entirely up to you. Contract for Difference (CFD’s) are geared or leveraged instruments. This means that a deposit from as little as 10% of the value of the CFD is required. Consequently, it is possible to hold a position 10 times greater than would be possible with a traditional investment. Clearly, this degree of gearing means that for a correctly anticipated price movement a greater profit will be generated. On the other hand, the risk of loss increases commensurately if the anticipated price movement proves to be ill founded. If the case of substantial and adverse market movements the potential exists to lose all of the money originally deposited and to remain liable to pay additional funds immediately to maintain the margin requirement. The counterparty to the holder of a long CFD position will have had to borrow the stock in the market and in order to fully mirror the economics of physical purchase interest will charged. The margin deposit is held to secure the performance of the contract and is not available to be set-off against the Contract Value. Therefore, a long CFD holder will pay interest on the day-to-day Contract Value. Conversely, the holder of a short CFD position will receive interest also based on the day-to-day Contract Value. Interest is typically calculated at a margin above or below the relevant Inter-Bank Offered Rate for long and short positions respectively. Other than shareholder privileges, a CFD reflect all corporate actions affecting the underlying stock or share. The net dividend declared by a company will be paid to the holder of a long CFD on ex-dividend date. This will be advantageous in cash flow terms as the dividend pay date will normally be several weeks after the ex-dividend date. Holders of short CFD’s pay 100% of the gross dividend declared and this must also be paid on the ex-dividend date. These payments reflecting the dividend are made on the ex-dividend date as, all things being equal; the share would be expected to fall by the amount of the declared dividend per share. Similarly, bonus and rights issues and splits are replicated in the CFD on the corresponding 'ex-date' CFD’s offer a number of investment opportunities and strategies, some of which are unattainable in traditional share investing. They can be summarized as: -
The markets are constantly moving 24 hours a day, during the trading week. It is good practice to place a 'stop loss' on your open position. This allows you to control any potential losses should the market move against you. There are a number of order types that you can place that facilitate risk management when trading CFD’s. By using these additional order types you have the ability to control potential profits as well as potential losses on your open positions. CFD Performance Like Shares, CFD investors benefit from normal market movements. Clients' open positions are valued in real time, with every tick of the market. Profits or losses similarly are credited to or debited from the clients account equity in real time. Limit Orders A limit order is used to place either a closing trade to take a profit on an open position at a predefined rate set by you, or as an opening trade at a more favourable rate than the then current price for that instrument.
GTC (Good Till Cancelled) Conditional orders (i.e. Limits / Stops / OCO's) can be placed GTC, Good 'Till Cancelled. A GTC order means that the order you place will remain in the market until it is either executed according to the terms of that order, or is cancelled by you. Important Note: If you close a position, you must cancel any related orders you have placed against that position. Failure to do so will mean that the order remains in the market and at risk of execution. Stop Orders A stop order is an order placed to limit the loss on an open position. It can also be used to enter the market at an inferior rate, allowing you to enter the market on a 'breakout' of the current trading range. One Cancels the Other (O.C.O) This is the combination of both a 'limit' and a 'stop' order. It is an order that can be used to take a profit if the market moves favourably to the open position or to limit the loss if the market moves against the open position. The execution of one order will automatically cancel the other order. The Kerford CFD service includes some particularly valuable features not usually available from our competitors:
CFD’s allow you to trade individual shares and stock indices without putting up the full underlying contract value, and offer substantial advantages over normal share trading: Risk Protection: You can trade with Limited Risk. If the market moves sharply against you, we guarantee that your position will be closed at your chosen Stop level—even if the move is overnight. No minimum Deal Sizes: There is no minimum deal size for CFD’s on individual shares. Immediate Dealing: We quote you a price and you can deal immediately; there is no irritating wait for an execution. Trading Shares on Margin With Kerford you can trade thousands of individual shares on margin using Contracts for Difference (CFD’s). CFD’s have substantial advantages over normal share dealing: Gearing: You can take a position in a share without having to put up the full underlying contract value. Instead you put up a deposit or margin as initial collateral. The minimum margin requirement can be just 10% of the contract value (or 5% for Limited Risk trades). The ability to go short: You can go long or short of any share that we quote. Other methods of shorting shares are often inconvenient and expensive. No Stamp Duty: There is no stamp duty to pay when you trade share using Contracts for Difference. Example: If you trade a £25,000 position each day, via a conventional stock broker you will pay the Government a staggering £27,500 in Stamp Duty over one year. With a CFD you are not physically buying the stock, so you are not liable for the 0.5% Stamp Duty. This will represent a significant saving over time, even for a relatively inactive investor/trader. Very Low Capital Requirements: CFD is an example of a ‘Margined’ trade. This means that instead of putting the whole value of the trade forward to the broker, you are only required to lodge a percentage of the value, known as your deposit requirements or margin and this will typically range from 5% to 33%. The advantages of being able to trade on margin or gear your investments is that you can either trade the same size positions as you would do with your broker but free up nearly all your cash to use elsewhere or you can use the facility to increase your average deal size in the hunt for higher returns on smaller price movements. The latter, naturally, is a higher risk option. Huge Range of Markets: Previously the retail CFD market was quite young and the markets covered were very limited. Nowadays the market is quite mature and the trader has access to pretty much any market or asset type that could be required. This allows the trader to profit from any market movements, anywhere in the world and in any asset type, all from one account. This is an incredible step forward for the retail market and the significance of this must not be over-looked. Market direction is now no longer important: Formerly the retail investor could only really make money in a rising market. The advent of CFDs (including spread betting) has meant that as far as the retail trader is concerned it is irrelevant whether the market is moving up or down, just so long as it is moving. With CFDs you are able to profit from a falling share price as well as a rising price (by shorting, i.e. selling a position that you do not have and buying it back later at a lower price, the exact opposite of what we normally do when we expect a price to rise.) Highly Flexible Trading: Nowadays it is usually possible to execute any trade size through an account. The standard commissions in the industry are still around the 0.25% mark. This is incredibly low cost and some brokers offer lower rates still but it is important to note that a company will usually make up the difference elsewhere in the service. Cap Your Potential Downside: There has been much in the press over the years about stop losses and limit orders, it is very wise to use limits stops to open and close positions automatically in your absence. Most brokers will allow this facility and it may be prudent to make use of it from time to time. The following is a basic example that illustrates how the mechanics of a CFD deal work. Example: Buying KerFX Opening the Position It is early February and you decide KerFX is looking cheap. The share is quoted at 419/420p in the market, and you buy 10,000 shares as a CFD at 420p, the offer price. The commission on the transaction is 0.25% or £105 (10,000 shares x 420p x 0.25%). There is no stamp duty to pay. While your position remains open, your account is debited to reflect interest adjustments and credited to reflect any dividends. Details of how these adjustments are calculated can be found in our Contract Details. Closing the Position By late March KerFX has risen to 453/454p in the market and you decide to take your profit. You sell 10,000 shares at 453p, the bid price. The commission on the transaction is 0.25% or £113 (10,000 shares x 453p x 0.25%). Your profit on the trade is calculated as follows: Profit on Trade: Closing level 453p To calculate the overall profit on the transaction you would also have to take into account the commission you have paid and the interest and dividend adjustments that have been credited or debited. Detailed CFD Example: For the active trader, stock markets have one major disadvantage: it is not easy to go short. When you trade Contracts for Difference, it is as easy to go short as to go long. This example shows how you can use a CFD to sell a share short and also contains details of how dividends and interest rate adjustments work. Example: A short position in Kerfo Opening the Position It is June and you think Kerfo is about to fall. The share is quoted in the market at 537/538p. You sell 5000 shares as a CFD at 537p, the bid price. The commission on the transaction is 0.25% or £67 (5000 shares x 537p x 0.25%). There is no stamp duty to pay. Because you have taken a short position, your account is credited to reflect interest adjustments and debited to reflect any dividends. Interest Adjustments: The interest credit on your position is calculated daily, by applying the applicable interest rate to the daily closing value of the position. In this example, the applicable interest rate might be 4.0% and the closing price of the shares on a particular day might be 534p, giving a closing value of £26,700 (i.e. 5000 shares x 534p). So the interest credit for the position for this particular day would be £2.93 (i.e. £26,700 x 4.0% / 365). Interest adjustments are calculated daily and posted to your account on a weekly basis, or more frequently on request. Dividend Adjustments: In July your position is still open at the time of the Kerfo ex-dividend date. The amount of the net dividend is 7p per share and this is debited from your account. The adjustment is calculated as follows: 5000 shares x 7p = £350 Closing the Position By early August, Kerfo has risen to 563/564p in the market and you decide to cut your loss and close the position. You buy 5000 shares at 564p, the offer price. The commission on the transaction is 0.25% or £70 (5000 shares x 564p x 0.25%). Your loss on the trade is calculated as follows: Loss on Trade Closing level 564p Calculating the overall result To calculate the overall loss on the transaction you also have to take account of the commission you have paid and the interest and dividend adjustments. In this example, you might have held the position for 65 days, earning a total interest credit of, say, £185. You have been debited a dividend adjustment of £350. The overall result of the trade is a loss, calculated as follows: Overall loss Loss on trade £1350 As CFD’s become ever more central to mainstream investment policies, increasingly our clients are looking for professional advice to support and assist their trading decisions. Our expert and experienced team of advisors will be happy to help you to develop a CFD investment strategy to suit your style and aims. CFD’s can be used in a number of ways to support a variety of investment goals: Lowering Portfolio Risk: By hedging an existing portfolio with CFD’s may reduce or eliminate exposure without the need to realize taxable capital gains from an existing holding. Sector-wide Investment: You can gain or reduce exposure to a particular sector without necessarily selecting individual stocks on which to trade. Short-term Gains: CFD’s provide a cost-effective means of short-term trading with minimal effort and outlay, and no constraints of settlement period or expiry. The Advisory Service is available to Kerford clients who are looking to work an extensive CFD portfolio. We offer regular reports and trading recommendations plus independent advice on specific stock trades. All our advice is provided with the sole aim of helping you derive an investment strategy that meets your goals. Our technical analysis is grounded in theories and an invaluable means of targeting areas of support and resistance in order to enter stocks at the right levels. You may wish to seek advice from a financial advisor before opening this account. The risk of loss in leveraged equity trading can be substantial. In the event that you choose not consult your financial advisor, you should therefore consider if such trading is suitable in light of your own financial position and investment objectives. FAQ’s 2. What is the Contract Value? 3. Do I have to pay the full Contract Value of Equity
CFD? 4. What is a Margined Transaction? 5. What Margin is required for Equity CFD? 6. Can I buy or sell CFD’S? 7. Why is interest charged or credited? 8. What happens when a company pays a dividend? 9. Will I have to pay Stamp Duty when buying Equity
CFD? 10. Will I have to pay commission? 11. What Spread can I expect to see in the bid and
offer prices? 12. What stocks are available? 13. How often can I trade? 14. Can I take or make delivery of a stock by trading
Equity CFD? 15. How long CFD’s are held? 16. Do I need to have a specialist CFD broker or can I use my traditional
stockbroker? 17. How do CFD’s compare to Spread Bets? 18. Are CFD’s available on other products? 19. What markets can CFD’s be traded in? 20. How are dividends handled? 21. What is the minimum and maximum trade size I can transact using
CFDs? 22. How will corporate actions such as a Rights Issue affect my
CFD?
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