What are CFDs?
A CFD (Contract for Difference) is an agreement between two parties to exchange, at the close of the contract, the difference between the opening price and closing price of the contract, multiplied by the number of underlying stocks specified in the contract.
A CFD offers you all the benefits of trading a security without having to physically own them.
Simply put, it is a contract that mirrors the performance of a security or index. It is traded on margin, and just like physical shares your profit or loss is determined by the difference between the price you buy at and the price you sell at.
Contracts for Difference (CFDs) offer you an alternative powerful and flexible investment instrument to stock trading.
The CFD system gives direct market access to the stock markets, allowing investors to benefit from either a rising or falling market, by taking long or short positions over selected stocks without owning the stocks.
CFDs are traded in a similar way to ordinary stocks, bonds, currencies, and any other financial instrument.
It allows the investors to gain exposure to price movements of the underlying security, without the need for ownership.
It also allows traders to take long or short positions, and instead of paying the full contract value the trader is only required to place a cash deposit (known as margin) as collateral.
CFDs do not have an expiry date.
As long as the investor is able to top up variation margin and interest payment as required, the investor is able to hold the position indefinitely.
CFDs are used also to hedge your portfolio.
How is trading CFDs different to investing in shares?
Unlike investing in shares, when you trade CFDs, you are not buying or trading the underlying asset.
What you are buying is a contract between yourself and the CFD provider.
Because all you own is a contract with the CFD provider, you are also taking a bet that the CFD provider is in a sound financial position and will be able to meet their obligations to you.
Also, while the value of the CFD is derived from the value of the underlying asset, it may not track it exactly.
These small differences can significantly affect any gains or losses you make.
What is the ‘underlying asset’?
When you buy or sell a CFD, you are making an agreement to trade the difference in the value of an underlying asset (sometimes called the ‘underlying security’ or the ‘reference asset’) between now and a future date.
But you are not actually trading the underlying asset itself.
CFD providers allow you to buy or sell CFDs on a range of underlying assets.
Shares are the most common underlying asset. But most CFD providers also allow you to trade CFDs on other underlying assets, such as commodities and foreign exchange (FX).
They may also allow you to trade certain market indices, such as the ASX 100, which aggregates the price movements of all the top 100 stocks listed on the Australian Securities Exchange (ASX).
If you are thinking of trading CFDs, you need to know and understand both how CFDs work and also about the underlying assets on which the CFDs are traded.
For example, if you want to trade CFDs where the underlying asset is FX, then you must have knowledge and experience of the FX market and the conditions that affect that market.
All CFD providers are legally obliged to give you a disclosure document called a Product Disclosure Statement (PDS) before you open an account.
This document should clearly set out what the underlying assets of any CFDs are. Read this information carefully.
If you don’t understand how CFDs work and how the underlying asset, such as FX, works, then you are unlikely to be able to trade CFDs on that asset successfully
Why to trade CFDs
Flexibility to Short
One of the main appeals of CFD trading is that you can short sell without owning the underlying stock.
You can open a short position with the aim of profiting from the falling security price.
It is not necessary to own the physical stocks in a company in order to go short via a CFD.
If you consider a stock to be over-valued, you can go short with a CFD and benefit from a fall in its stock price.
There is no extra commission charge incurred when you keep the contracts open. In fact, you can hold your short positions indefinitely, provided you are not in margin call.
No Expiry Date of Contracts
Gives you the freedom to roll over your open positions on a daily basis until you choose to close the position*.
Transparent Pricing
Our Direct Market Access system gives you the same transparent pricing and liquidity as stock trading.
Ease of Trading
There is more than one mode of trading CFDs — through broker or online. The online system for CFD trading includes features like good-for-the-day orders, real-time portfolio and daily account management.
Corporate Action
As an owner of an Equity CFD you will have your account adjusted to reflect cash dividends credited or debited on the underlying stock and to participate in stock splits, just as you would if you owned the physical stock. The only difference is that with a CFD you are not entitled to any voting rights.
Diversification
Diversification is the allocation of existing funds to a wide variety of assets with the aim to limit exposure to the risk of any particular asset class.
With a well diversified trading portfolio (which may be a selection of both long and short positions), it is possible to reduce your losses if an individual stock or even an entire asset class loses ground.
Hedging of Portfolio
Equity CFDs offer the perfect hedge for individual stocks in your portfolio.
Direct 1 to 1 relationship in price and quantity. Choose to hedge a specific part or the whole of your stock portfolio.
Be stock or sector specific.
Hedge your portfolio via Equity CFDs to tailor the hedge to your requirements.
By using CFDs as part of an existing portfolio, you can efficiently and effectively hedge against any adverse price movements in your stock portfolio.
A decrease in the price of a stock can be hedged by taking a short position in a CFD over the same stock.
This is particularly useful if the investor has a negative short-term view on the stock’s price, but has a more positive longer-term view or otherwise would like to hold onto the underlying stocks.
Leverage
CFDs are traded on margin, using leverage to maximise your trading capital.
This means for a small outlay you can open larger positions in the market compared to that of traditional stock trading.
CFDs allow you to bet on rises and falls in shares, currency and other assets while only putting up a small amount of your own money.
You are leveraging off the money you do have, in the hope of making more.
With CFDs, you only have to put in a fraction of the market value of the underlying asset when making a trade, sometimes as little as 1%. The remaining 99% of the value of the asset is covered by the CFD provider.
Even though you only put up 1% of the value, you are entitled to the same gains or losses as if you had paid 100%.
The actual percentage of the market value that you will be asked to put in will vary for different CFD providers, and for different underlying assets.
This can make CFDs seem very attractive.
Even if you don’t have the money to buy the underlying asset itself, you can share in potential gains and losses on the value of that asset.
But because you are trading with leverage, the gains and losses are magnified—and the risks are much greater. You can end up losing much more than you put in.
Margin requirements
To open a CFD trade, you need to pay a margin, which will be a percentage of the total value of the trade.
For example, if you buy a CFD over XYZ shares, you may need to pay a margin equal to 5% of the current XYZ share price. The initial margin amount will be withdrawn from your account by the CFD provider when you place the trade.
Different CFD providers will have different margin requirements for CFDs over the same underlying asset.
Margin requirements will tend to be higher for CFDs over shares than for other assets.
Even if you shop around for the lowest margin rates, you need to remember that regardless of how little margin you pay, you are always responsible for the full face value of the trades you make.
Paying less margin upfront means that small price fluctuations can have a bigger impact on your trades.
For example, if you have a trade open and the market moves against you, the CFD provider may demand that you pay an additional margin to keep the trade open.
If you have cash in your trading account, this additional amount will be automatically debited.
However, if you don’t have enough money in your CFD trading account, the provider may make a margin call demanding extra funds.
Margin calls and liquidation
A CFD provider will make a margin call when you have a CFD trade or trades open which have lost money, and there is not enough cash in your CFD trading account to cover this loss.
The CFD provider may contact you, either by telephone or by email, to alert you to your margin call requirements and to ask you to put extra money in.
However, they are not obliged to do so. Many providers expect you to monitor your account regularly and so may not notify you of a margin call.
If you get a margin call, you will usually have to pay in extra money that same day , or face automatic closing (called ‘liquidation’) of one or all of your trades.
CFD providers will also usually set a ‘liquidation’ level on your CFD trading account.
This is the level at which any open CFD trades will be closed if you do not have enough money in your account to cover adverse movements on your trades.
CFD providers may express this level as a percentage, say 10–20%, of your margin requirement.
For example, you might be required to keep $1,000 in margin.
If the balance in your account goes down to $100 (at 10% liquidation level), the CFD provider may liquidate your open trades, as well as charging you a fee (penalty) for the liquidation.
The PDS and the terms and conditions of the client agreement should clearly set out margin call procedures and your rights and obligations.
It should also set out the circumstances in which the CFD provider will liquidate your trades.
Initial Margin
Margin is a term derived from the futures market, and provides for leveraged trading in financial products.
In its most simple format, if you offered the trading of an instrument at 5% margin, you are in fact saying that you need to only deposit 5% of the total purchase cost of that deal to open that position.
Example:
You purchase 100 of shares in Company A at £1, but only deposit 5%, or £5 towards this transaction.
This is attractive to people who do not want to hold the position for the long term, and provides for leverage when trading.
In this case the client has only paid £5, if the stock they purchased goes up 5p the next day, and they sell, they will have made a £5 profit on a £5 investment, or 100% return (less roll-over costs).
If they had been cash buyers of the shares they would have made a 5% return.
A 5% margin provides a trading leverage of twenty times the initial deposit or 1:20.
Variation Margin
Variation Margin is the difference in margin requirement once you have opened a position, and provides for trading profits and losses.
Example:
You buy 2000 Vodafone CFDs, at 140.25. This provides a notional position of 2000 x 140.25p = £2,805.
Vodafone is margined at 5% so you would need at least £140.25 Initial Margin to hold this position.
If Vodafone’s price goes down to 138, you would now show a loss on your account of £45 (2.25p lost at 2000 CFDs).
This loss (known as variation margin) is subtracted from the Initial Margin of £140.25, leaving a deposit of £95.25.
However, you still hold Vodafone at a position of 2000 CFDs now at 138.
This gives a notional value of £2,760 (i.e. 2000 X 1.38).
Knowing that Vodafone has a 5% margin requirement, you would need a minimum of £138 Initial Margin to cover this position.
As your Initial Margin is now only £95.25, you are in deficit margin by £42.75. This shortfall or deficit is known as
Margin Calls
If the market moves against you and your Equity Balance falls below your Initial Margin requirement you have the option to:
- close one or more of your open position(s), in order to reduce your Initial Margin requirement to the required level; and/or
- remit further funds to your account as deposit in order to maintain the Initial Margin requirements.
We may or may not make a margin call in these circumstances, (which is a request for you to deposit additional cleared funds on your account to maintain your open positions).
In any event if you fail to maintain sufficient margin on your account or sufficient funds on your account to meet the margin requirement then we may close your open position(s) or take any action that we deem necessary.
Once your equity falls below your initial margin requirement, it is advisable that you place a ‘stop loss’ order with us to try and avoid a deficit balance on your account.
Liquidation or Stop out Level
The broker may place ‘Stop loss’ orders for your open positions, at a level where the total Equity Balance falls below the minimum required Initial Margin requirement.
This level is referred to as the ‘stop-out level’, below which your open positions may be automatically closed out or ‘liquidated’.
All liquidations on your account will be undertaken at a reasonable and fair valuation. You will be liable for any loss in the account as a result of any such liquidation.
Once the stop-out level has been triggered, you will not be allowed to trade on your account until the Equity Balance is restored to the required Initial Margin level.
Margin calls can be made at any time during the day and alternative payment arrangements must be made if you cannot be contacted or if you are travelling. Please refer to our Terms of Business, which addresses the non-payment of margin calls and change in margin requirements.
Example of a CFD trade
A research on Beta Pty Ltd (Beta) shows that its share price is undervalued, so you decide to take a long position on CFDs over Beta shares.
The current price of a CFD over Beta shares offered by the CFD provider is $5.
You place an order to buy 4,000 Beta CFDs.
Your order is accepted by the CFD provider at $5 per CFD. The total contract value is $5 x 4,000 = $20,000.
The CFD provider requires a 5% margin to open a trade, which is deducted from your CFD trading account.
The margin is equal to $20,000 x 5% = $1,000.
The provider also charges you a commission of 0.15% of the contract value, which is $30 on this trade.
What happens next depends on what happens to the price of Beta shares.
Any gains you make on this trade are also dependent on the CFD provider being willing to accept his trades and meeting all their obligations to him.
This includes crediting any gains to his CFD trading account after the closing of a position and transferring them to his bank account upon request.
How the price of Beta shares affects your return.
If the price of Beta shares raises to $6.00 (+20%), your gain would be $3,934.00, or 393% of your initial margin.
If the price of Beta shares raises to $5.50 (+10%), your gain would be $1,937.00, or 194% of your initial margin.
If the price of Beta shares raises to $5.25 (+5%), your gain would be $938.50, or 94% of your initial margin.
If the price of Beta shares raises to $5.10 (+2%), your gain would be $339.40, or 34% of your initial margin.
If the price of Beta shares stays unchanged at $5.00, your loss would be -$60.00, or -6% of your initial margin.
If the price of Beta shares falls to $4.90 (-2%), your loss would be -$459.40, or -46% of your initial margin.
If the price of Beta shares falls to $4.75 (-5%), your loss would be -$1.058.50, or -106% of your initial margin.
If the price of Beta shares falls to $4.50 (-10%), your loss would be -$2,057.00, or -206% of your initial margin.
If the price of Beta shares falls to $4.00 (-20%), your loss would be -$4,054.00, or -405% of your initial margin.
Risks associated with CFDs trading
Listed below are some of the risks associated with CFD trading.
Effect of “Leverage”
Transactions in CFD carry a high degree of risk. The amount of initial margin is small relative to the value of the CFD transaction so that the transaction is highly ‘leveraged’ or ‘geared’.
A relatively small market movement will have a proportionately larger impact on the funds you have deposited or will have to deposit; this may work against you as well as for you. You may sustain a total loss of the initial margin funds and any additional funds deposited with the firm to maintain your position.
If the market moves against your position or margin levels are increased, you may be called upon to pay substantial additional funds on short notice in order to maintain your position.
If you fail to comply with a request for additional funds within the specified time, your position may be liquidated at a loss and you will be liable for any resulting deficit in your account.
Risk of Inadequate Margin
Positions are marked- to- market on a daily basis with payments being settled daily to account for market movements.
This risk of loss in securing a transaction by deposit of collateral can be significant.
You may sustain losses in excess of your cash and any other assets deposited as collateral/margin with us.
You may be called upon at short notice to make additional margin deposits or shortfall fee payments.
If the required margin deposit or shortfall fee payment is not made within the prescribed time, you will be deemed in default and we may liquidate your CFD positions and supporting collateral without notice to you.
This may result in a loss for you. Such loss may be substantial. You must therefore carefully consider whether such a collateral/margin provision arrangement for trading in CFDs is suitable for you in light of your own financial position and investment objectives.
You should familiarise yourself with and understand what the requirements are for trading on margin.
In addition, you acknowledge that you are fully responsible for monitoring all your positions and knowing when you will be required to place additional margin.
If the required margin deposit or interest payment is not made within the prescribed time, we may close your positions without prior notification to you.
Finally, you may be called upon to deposit substantial additional margin, at short notice, to maintain your trade.
If you do not provide such additional funds within the time required, your trade may be closed at a loss and you will be liable for any resulting deficit.
Risk-reducing orders or strategies
The placing of certain orders (e.g. ‘stop-loss’ order, where permitted under local law, or ‘stop- limit’ orders), which are intended to limit losses to certain amounts may not be effective because market conditions may make it impossible to execute such orders.
At times, it is also difficult or impossible to liquidate a position without incurring substantial losses.
Strategies using combinations of positions, such as ‘spread’ and ‘straddle’ positions may be as risky as taking simple ‘long’ or ‘short’ positions.
Transactions in other jurisdictions
Transactions on underlying instrument listed in markets in other jurisdictions may expose you to additional risk.
Such markets may be subject to regulation that may offer different or diminished investor protection.
Before entering into such trades, you should be aware of the rules relevant to the particular transactions.
Currency Risks
Transactions in foreign markets or in foreign currency denominated instruments tend to involve different risks from domestic markets.
In some cases, the risks will be greater.
The potential profit or loss from transactions on foreign markets or in foreign currency denominated instruments will be affected by fluctuations in foreign exchange rates.
Any imposition by a country of exchange controls or other limitations or restrictions may cause payments to be made in the local currency instead of the original invested currency or may result in the inability to effect outward remittances of funds from such country, which can affect the value of your investment or your ability to enjoy its benefit.
Trading Facilities and Electronic Trading
As with all facilities and computer systems, you will be exposed to risks associated with the systems including the failure of hardware and software.
The result of any system failure may be that your order is either not executed according to instructions or is not executed at all.
You should also be aware that the Internet is not a completely reliable transmission medium and there may be delays in service provisions
Liquidity and Market Disruption Risks
Adverse market conditions may result in you not being able to effect CFDs, liquidate all or part of your CFDs, assess a value or your exposure or determine a fair price, as and when you require.
The normal pricing relationships between a derivative and the underlying asset may not exist in certain circumstances. The absence of an underlying reference price may make it difficult to judge “fair” value.
Shortage of Equity
A shortage in equity occurs when the Equity Balance falls below the required Initial Margin deposit. If your account has a shortage in equity you should only reduce your open positions, at least until the Equity Balance in your account is in excess of the required Initial Margin deposit.
Fees and charges (including interests)
You must pay the CFD provider fees and charges to trade CFDs.
In all cases, CFD providers will charge you for each order that you place on their trading platform.
This charge may vary from provider to provider.
In most cases, CFD providers will also charge you for additional information or research data, such as data on ASX or foreign market shares.
Some CFD providers may tell you that you have access to certain information free of additional cost, as long as you make a certain number of trades per month. But remember, you are still paying for those trades.
As well as fees and charges for trading, the CFD provider will charge you interest on any long CFD positions held open overnight.
Often interest is charged on the full face value of your trade. The interest rate you are charged will vary depending on the CFD provider.
The PDS and the terms and conditions of the client agreement should clearly set out all fees and any other charges. It should also clearly set out how interest will be charged on any leveraged trade.
While it may not indicate a specific amount, it should give you a method for calculating the interest and explain how and when interest is charged.
Make sure you understand what you are paying for and how you will be charged. Keep records of what you pay. If you have any complaints or disputes about fees and charges that you can’t resolve with the CFD provider, contact the provider’s external dispute resolution scheme.
General risks of over-the-counter transactions
A CFD is an over-the-counter transaction. You should be aware of the general risks of over-the-counter transactions:
Because prices and characteristics of over-the-counter financial instruments are often individually negotiated, there may be no central source for obtaining prices and there can be inefficiencies and a lack of transparency in the pricing of such instruments.
We make no representation or warranty that our prices will always be the best prices available to you.
Over-the-counter transactions may not be regulated or subject to a separate regulatory regime, compared to on-exchange transactions.
Finally, issues such as additional cost for rollover, gapping, speculative and volatile markets, regulatory issues, cash settlement, etc also require due attention.
Please make sure you have read and understood all information in the account opening forms, including the Terms and Conditions Applicable to Contracts for Difference and Risk Disclosure Statement for CFD Trading before commencing tradin