SINGAPORE--(Marketwire - Dec 5, 2012) - You may have heard traders and investors talking about 'contracts for difference'. They're more commonly known within the industry as 'CFDs', and are a popular way to speculate on the movement of market prices.
All in the name
Contracts for Difference are exactly that -- an agreement between two parties to exchange the difference between the opening price and closing price of a contract.
You can profit regardless of whether the price of your chosen market is rising or falling. For example, if you believe a market price will fall, you can sell a CFD on that market -- also known as 'going short'. If, however, you think the price of a market will rise, you can buy a CFD on that market (going long). If prices move against you you will suffer a loss.
Let's look at this risk/reward concept more closely, in simpler terms.
CFD trading example
Let's say that Singapore Airlines CFDs are currently trading at 10.48/10.49 (sell/buy). You believe that Singapore Airlines share price will rise in the coming days. You therefore go long on the airline company, buying 2,000 CFDS at 10.49.
You were right! Singapore Airlines share price rises and you decide to cash in your profits. Let's assume that Singapore Airlines CFDs are now trading at 11.10/11.11. You close your trade by selling at 11.10. The difference is then multiplied by the number of CFDs you decided to trade, in this case, 2,000.
The value of your opening trade before the market moved?:
- 2,000 CFDs x 10.49 cents = SGD20,980
The value of your closing trade after the market moved?:
- 2,000 CFDs x 11.10 cents = SGD22,200
The difference between the two prices is SGD1020 (SGD22,200 - SGD20,980), and that's your profit for the trade.
Of course, if the market had moved against you, you would have stood to net losses that could have exceeding your initial deposit, especially if you did not consider risk management orders such as stop losses.
For shares CFD trades, there is a 0.08% commission fee on every trade (with a minimum fee of SGD10) and a financing charge of 2.5% +/- 1 month SIBOR rate p.a for long/short positions applied every day until the positions are closed.
CFDs are a leveraged product which can result in losses greater than your initial deposit. Ensure you fully understand the risks.