A. In short, A CFD (Contract for Difference) is a financial derivative instrument where you’ll enter into a CONTRACT at one price, close it at another price FOR a profit or a loss depending on the price DIFFERENCE (between your entry and exit).
Basically, you’ll be exposed to the share price and the price movements, without actually owning the shares.
When you buy a CFD you’ll pay a fraction of the actual underlying share price (known as the margin deposit).
But you’ll still be exposed to the full value of the share.
That’s why It’s called a derivative.
For now, let’s look at an example trading the underlying share versus trading the CFD on the share.
EXAMPLE: Buying 20 Aspen shares
Let’s say Aspen is trading at R144.00 per share. If you want to buy and own 20 shares you’ll have to pay R2,880 (R144 X 20 shares).
When you invest in shares, the maximum amount you can lose is the R2,880 should the share go to zero.
When you buy the shares, you’ll have a number of benefits including: Being able to attend AGMs, vote and receive physical dividends.
Now let’s see how this differs when you buy 20 Aspen CFDs.
EXAMPLE: Buying 20 Aspen CFDs
If Aspen is trading at R144 per share, you’ll need to see what Aspen’s CFD will cost.
This is known as the margin per share. If the margin is 10% this means, you’ll only pay R14.40 and you’ll still be exposed to the full value of the share (R144.00).
If you bought 20 Aspen CFDs you’ll therefore only have to pay R288 (R144 per share X 10% margin per CFD X 20 CFDs).
When you buy 20 Aspen CFDs you’ll be exposed to the full value of R2,500.
This means, if the share goes to zero, even though you risked only R288 you’ll could lose R2,880 should the share go to zero…
The beauty of trading CFDs, is you’ll be exposed to more by paying less…
And this is how us traders are able to gear up their profits and losses compared to when trading shares.
By managing your risk, you’ll know how to maximise your profits and minimize your losses…
If you’re ready to take your trading to the next level, you’ll need to understand how CFD trading works to a T.
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Timon Rossolimos,
Managing Editor, Trading Tips
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