BARXdirect: CFDs Guide

• What are CFDs?
• Margins and gearing
• Pricing of CFDs
• How do CFDs work?
• Trade Types
• How do CFDs compare to traditional sharedealing?
• Trading strategies
• CFDs - Risks
• Frequently Asked Questions

 

What are CFDs?

CFDs (Contracts for Difference) are an agreement between you and a broker to exchange, at the closing of the contract, the difference between the opening and closing prices, multiplied by the number of shares in the contract.

You predict whether the price will rise or fall and invest money on this basis. You take a long position if you think the price will rise, or take a short position if you think the price will fall. You make a profit or a loss depending on whether you have correctly predicted the direction in which the price will move. This means you can make money even if the price of a share falls, if you have predicted correctly and ‘gone short’. Going short means that you sell stock you don’t own then buy it back later, hopefully at a lower price to realise a profit.

In CFD dealing, you do not physically buy or hold the physical underlying share; you only have indirect access to the price performance. However, you would benefit from a dividend payment when going long.

 

Margins and gearing

CFDs are dealt on a margin basis, and you secure the transaction by paying a deposit, also known as a Margin Requirement, of around 10% of the contract value. So if you wanted to undertake a contract worth £20,000 you would need a Margin Requirement of £2,000. You must also be able to maintain the required margin, which may involve topping up the deposit if the level of exposure increases during the period of the contract.

The benefits of margin trading are that if you make a profit, you haven’t had to make a full outlay of collateral, you are able to take a much larger position than you would normally be able to, and there is the potential of significantly greater profits than traditional share dealing (also known as ‘gearing’).

However, you should note that gearing also means that the potential for losses is equally increased. Because of this, you should read this guide and the application pack and brochure, with the risk warnings, before dealing in CFDs. You should consult an independent financial adviser, if you are unsure whether CFDs are a suitable

 

Pricing of CFDs

A CFD contract price is worked out using the calculation below:

The unit value of the underlying share x the percentage deposit requirement x number of shares

For example, if you were dealing a CFD on 600 shares of a share with a market price of 800p:
800 x 10% x 600 = (48000p) £480

Commission rates apply to CFDs in the same way as traditional share dealing, although no stamp duty is charged on CFD transactions. See our for our CFD commission rates.

For CFD positions that are not opened and closed within the same business day there are other charges and/or credits. This includes an interest charge which is also shown in our .

In essence:

• If you go short then you receive an interest credit to your account
• If you go long, then you pay the interest (also known as a daily financing charge)

 

 

How do CFDs work?

The best way to understand how a CFD works is to look at some examples of CFD deals.

Going long – buying a CFD
You are described as going long if you believe the price will rise, and enter into a contract for this. Like traditional share dealing, going long means a profit if the price rises but a loss if the price falls. If the CFD is not opened and closed on the same day then a daily financing charge will apply. There will also be commission charged on the transactions.

A client believes that the price of Company X will rise, so decides to buy a CFD for 10,000 shares at 193p. The deposit required is 10% of the contract value. In the same day, the price rises to 267p, and so the client decides to sell and close the position. There is no stamp duty, and no financing charge as the deal was completed in one day.

Opening the position			Closing the position
Value of shares 10,000@ 193p		£19,300	Sells 10,000 shares @ 267p		£26,700
CFD commission		£28.95	CFD commission		£40.05
Deposit required		£1,930	Profit		£7,331

 

Going short – selling a CFD
You are described as going short if you believe the price will fall, and enter into a contract for this. Unlike traditional share dealing, going short means a profit if the price falls but a loss if the price rises. If the CFD is not opened and closed on the same day then a credit will be paid to your account. There will also be commission charged on the transactions.

A client believes that the price of Company X will fall, so decides to sell a CFD for 10,000 shares at 193p. The deposit required is 10% of the contract value. In the same day, the price falls to 100p, and so the client decides to buy back and close the position. There is no stamp duty.

Opening the position			Closing the position
Value of shares 10,000@ 193p		£19,300	Buys back 10,000 shares @ 100p		£10,000
CFD commission		£28.95	CFD commission		£15.00
Deposit required		£1,930	Profit		£9,256.05

 

Why not check out our BARXdirect: CFDs & Financial Spread Trading simulator to experience CFD dealing for yourself?

Trade Types
As well as dealing CFDs on equities, you can also deal CFDs on many world indices, including FTSE 100, NASDAQ, Dow Jones, S&P, Dax, CAC, Nikkei and Hang Seng.

The same principle applies – go short if you think the market index is going to fall, or go long if you think the index is going to rise. This can be useful if you want to follow a specific market trend rather than individual shares. In addition, margin requirements for index trading are generally lower than for other CFDs.

 

How do CFDs compare to traditional share dealing?

As CFDs are margin traded, your deposit can allow you to take a larger position than you would if you were purchasing ordinary equities, offering you a much greater return on your investment (ROI). This is called gearing and it means you can potentially make much greater profits, or losses.

To see the effect of gearing, here is an example of a CFD deal compared to an equity deal, where the investor uses the same amount required for a CFD deposit to buy ordinary shares instead.

Opening the position
		CFD Deal		Equity Deal
Price of Company Z		112p		112p
Number of shares		20,000		2,000
Value of shares		£22,400		£2,240
Commission		£33.60		£17.50
Stamp Duty		£0		£11.20
Total value of transaction		£22,433.60		£2,268.70
Deposit required		£2,240		£0
Initial cost		£2,273.60		£2,268.70

Closing the position
		CFD Deal		Equity Deal
Price of Company Z		115p		115p
Number of shares		20,000		2,000
Value of shares		£23,000		£2,300
Commission		£34.50		£17.50
Difference in share value		£600		£60
Financing (3 days)		£9.67		£0
Profit (difference - commission charges)		£522.23		£13.80
Percentage ROI		23.32%		0.61%

 

As shown above, for the same initial outlay (excluding charges), you can acquire a much larger position, and make a greater profit and substantially increase the return on your investment. You should note that any losses would be equally multiplied.

 

Trading Strategies

Because of their nature, it is possible to use CFD dealing strategically, in several ways. Some investors use CFDs for the following:

• Short term trading – the ability to deal on a margin basis, with no stamp duty to pay make CFDs attractive for investors hoping to benefit from short term price movements
• Pairs trading – where an investor takes a long CFD in a company who they believe is undervalued while going short on another more expensive share in the same sector or index itself.
• Hedging – investors can use CFDs to hedge against price falls in existing shareholdings. Investors can take out a short CFD in the shares rather than selling the actual shareholding to buy them back later, and this often proves to be less expensive. If the share price falls, then investor would lose money on the shareholding but make money on the CFD. If the share price goes up, then although the investor would lose money on the CFD, the shareholding would have increased in value.
• Tax-efficient trading – investors who have an existing holding in a company can sell CFDs against this, allowing them to control the time at which they crystallise capital gains or losses, especially useful around the end of the financial year.

 

CFDs – Risks

Dealing in CFDs is a high risk investment, and so you should only deal in CFDs if you understand the risks.

There are several risks that you should consider before beginning to deal in CFDs.

1. Gearing: Due to the nature of CFDs the benefits are multiplied by a ratio of typically 5, then likewise so is the potential loss. So while CFDs are potentially more rewarding than ordinary share dealing, this also means that the risks and potential losses are also greater.

2. Deposit and Margin Requirements: CFDs do not require the full amount of the transaction value to be paid initially. When you take out a CFD, you will be asked for a deposit for that transaction, typically around 10%. CFDs can remain open as long as you want, and so the CFD must always have sufficient collateral support to cover potential losses. If a CFD moves into a loss-making position, then the broker can make what is known as a ‘margin call’. This is where you would be asked to deposit additional funds to ensure that the CFD remains solvent and is not closed by the broker.

• All individual margin positions must be supported by the client
• It is the responsibility of the client to monitor CFD positions
• We reserve the right to close all margin positions not supported.

3. Price movements: rapid price movements in share price need to be monitored closely as they can dramatically alter your level of exposure. For example if a stock collapses due to an unexpected press announcement then a client who has purchased long in the stock runs the risk of heavy losses unless they are able to exit immediately.
Losses can be minimised by using Stop losses and Guaranteed stop losses.

4. Interest: Interest payments are required to support long positions that are held overnight. The rates tend to be more attractive than those for a typical high street personal loan but more than the Bank of England base rate. They are based on an interest rate at which Banks lend money to each other.

5. Shareholder privileges: with CFDs you don’t actually own the shares so you do not receive all the privileges normally associated with share ownership, such as voting or invitations to AGMs. Dividends (at 90% of net value) are credited to your account if you hold a long position, and debited (at 90% of net value) from short positions held at the close of business the day before a dividend is due.

Risk Warning
CFDs carry a high level of risk to your capital and you should only deal with money you can afford to lose. The value of investments can fall as well as rise and you may lose significantly more than your initial margin payment. This online guide should be read along with the application pack and brochure you receive when you apply for CFD dealing with Barclays Stockbrokers. We do not recommend that CFD dealing is a suitable investment tool for all types of investor. We recommend that you consult an independent financial adviser if you are uncertain whether CFDs are the right investment vehicle for you. You must understand and accept the terms and conditions contained in the application pack, and sign a risk warning notice before you begin to deal in CFDs.

 

Frequently asked questions

Q. Do I need to hold any other account to deal CFDs with Barclays Stockbrokers?
A. No. You can open a BARXdirect: CFDs account without holding any other Barclays Stockbrokers account.

Q. Do I need a separate login for my CFD account?
A.  Yes, you will need a separate login to allow you to view and deal on your BARXdirect: CFDs account. You will be given this information when you open your BARXdirect: CFDs account.

Q. Can I deal CFDs by telephone?
A. Yes, you will be able to place CFD deals by telephone during the relevant opening hours.

Q. Do you offer guaranteed stop losses as part of the service?
A. These are available on limited stocks and when dealing by telephone only.

Q. What is the minimum amount I can deal in CFDs?
A.You can deal from as little as one CFD.

Q. What are the charges for dealing in CFDs?
A. A deposit of around 10% of the contract value is needed when you open the position. Commission is charged on opening and closing a CFD position. Also, if you hold a long position overnight, then a daily financing charge will apply.

Q. Will my CFD deals count towards my deal count?
A. No. CFD deals will not qualify for reduced commission, or be eligible to add to your deal count.

Q. Who do I contact for more information on CFD dealing, or if I have a question?
A. BARXdirect: CFDs team - call them on 0845 601 7788* or e-mail them on support@barclaysstockbrokerscfds.co.uk

---

*Calls to 0845 numbers from a BT residential line will cost no more than 4p per minute, plus 9.9p call set-up fee (correct as at April 2010). The price on non-BT phones may be different; please check with your service provider. You can only use these numbers if you are calling from the UK; if calling from outside the UK, please call +44 141 352 3909. Calls may be recorded to monitor the quality of our service, to check instructions and for security purposes.