LONDON, June 17, 2011 /PRNewswire/ --
A CFD, or "contract for difference", is an agreement between two parties to exchange the difference in value of a particular share from the time at which the contract is opened to the time at which it is closed. For example, if you were CFD trading (http://www.cityindex.co.uk/cfd-trading/) and bought a CFD at $10 before selling it at $15, you would receive the $5 difference. Conversely, if you bought a CFD at $10 and sold it at just $5, you would pay the $5 difference.
Like spread betting, CFD trading essentially allows you to trade on a huge range of markets without ever owning the underlying instruments. And because you never own the share or product in question, in CFD trading you can profit from a falling market as well as rising one.
CFD trading example
Imagine M&S shares are trading at 325.9/326p (bid/offer) in the underlying market and you believe this price will rise over the coming weeks. City Index share prices track the underlying market, and so its price for M&S shares is 325.9p/326p. You decide to buy 10,000 CFDs of M&S at 326p, and pay a commission of 0.1% of your total trade value.
Sure enough, M&S shares rise in the underlying market the following week and you decide to cash in on your profit by closing your CFD trade, when the buy/sell price for M&S share CFDs is 330.9p/331p. You sell 10,000 CFDs at 330.9p, incurring a further 0.1% commission charge.
Now remember, CFDs are an agreement between two parties to exchange the difference between the closing price of a contract and the opening price of a contract. The difference in value of trade from open to close will net you a profit or a loss.
In this case, the underlying market moved 4.9p in the direction you had predicted. So your closing value is £33090 (10,000 x 330.9p), which is a marked increase from your opening value of £32600 (10,000 x 326p).
The net result is a profit of £490 (33090 - 32600) before commission.
If the trade had moved the other way, with Marks & Spencer's share prices falling instead of rising as you had expected, you would have ended up in a long position. Let's say M&S shares fell from your opening buy price of 326p to reach 321p, a movement of 5p against the direction that you had predicted.
Your closing trade value would be £32100 (10,000 x 321p), a decrease from your opening value of £32600 (10,000 x 326p), thus resulting in a loss of £500 before commission.
This is the single most important thing to remember about CFD trading. Although the profit potential is large, so is the loss potential. Never forget CFD trading losses can exceed your initial deposit, so research every trade carefully.
About City Index:
Today more and more individual traders are discovering the benefits of derivatives, and many of them are discovering them through City Index trading platforms.
As a group, we transact in excess of 1.5 million trades every month for individuals in over 50 countries worldwide. We provide access to a wide range of instruments including margined foreign exchange, contracts for difference ( CFDs) and, in the UK, financial spread betting.
We constantly look to widen the range of assets we offer, improve the performance of our platforms and expand the range of services we provide. The result is that our customers benefit from innovative trading tools with transparent pricing, competitive spreads, and a high standard of customer service and support. Visit http://www.cityindex.co.uk/ for more information.
SOURCE City Index