This site uses cookies. By continuing to browse the site you are agreeing to our use of cookies. Read our privacy notice.

What are CFDs?

CFDs are a way of trading on the price movements of financial markets around the world without buying or selling the underlying asset directly. They provide the opportunity to make profits (or losses) from a wide range of markets including equities, indices, currencies and commodities.

CFDs can be used to speculate on upward or downward price movements, making them a flexible alternative to traditional trading.

A brief history of CFDs

CFDs were first created in London in the early 1990s. They were initially used by hedge funds to short sell the market while using leverage. It also allowed these hedge funds to avoid paying stamp duty, similar to members of the London Stock Exchange.

By the late 1990s, CFDs were introduced to private investors. The technology boom led to growth in online trading platforms, making it easy for investors to see live prices and trade in real time.

Over the last decade, CFDs have seen incredible growth in the UK. They are also beginning to span the globe, having been introduced across Europe, Japan, Canada, Australia and South Africa.

How do CFDs work?

A CFD (Contract for Difference) is basically an agreement to exchange the difference between the opening and closing value of a contract at its close. The price of your CFD will then replicate the price of the underlying asset giving you a profit (or a loss) as the price of the underlying moves.

There are no expiry dates on CFDs, as a result you can run a position for as long as required.

CFD prices

As with traditional share dealing, CFD prices are quoted as a Bid (the price you can sell at) and an Offer (the price you can buy at). You then buy or sell a CFD based on the value of a certain amount of the underlying asset.

Margin trading

Margin trading enables you to trade an entire portfolio without tying up large amounts of capital. When you lodge a security deposit of, say just 20,000 (or equivalent currency) in your account, you can typically trade up to 200,000 worth of shares. This is a leverage factor of 10:1 or, to put it another way, a 'margin requirement' of 10%.

Although the normal margin requirement is 10% for CFDs in FTSE 350 shares, some of the leading shares may require only 5% margin. This represents a leverage factor of 20:1. For smaller companies or if a share price is notably volatile, the margin requirement may be set above 10%.

Trading CFDs on margin allows you to take large market positions in relation to the money you have deposited. Margin trading magnifies both your profits and your losses.

You must maintain your margin if the market moves against you and your deposited funds do not cover open position losses and margin requirements. This may mean sending additional funds at very short notice and/or reducing the size of your positions, which is known as a 'margin call'.

Risk management

Many investors choose to limit their risk - or protect a running profit or open position - by placing a 'stop-loss' order, which closes out their position automatically once a set price level is reached.

While Galvan highly recommends using a stop-loss, we should point out that your stop-loss might be filled at a worse price than you had requested. This 'slippage' can happen in fast moving market conditions, or where a share opens a trading session well away from its previous close.  

We are able to place your account with a market maker offering a guaranteed stop-loss facility for a commission premium. However, guaranteed stop-losses may only be available on larger, more liquid securities.

Website design and build by Buzz Interactive

Copyright 2016 © Galvan Research and Trading is a trading name of Trade Facts Ltd (FCA number 401179)

Trading in Contracts for Difference may not be suitable for all investors due to the high risk nature of the product. You may lose all or more of your initial deposit through the use of leverage and may be required to make additional payments by way of margin on a frequent and sometimes daily basis. Failure to do so can result in the closure of part or all of your position. Please refer to Galvan’s risk warning.