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The long and short of CFD trading investments

CFD trading is another form of trading on the stock exchange where it’s important you are well aware of the risks involved. CFD stands for Contracts for Difference.

Peter Switzer, founder of Switzer Financial Services, stresses that CFD trading isn’t for the conservative investor. There is much to learn about them.

CFDs can be very risky and traders are open to very large losses if they don’t cover their options properly.” 

1. What are CFDs?

According to ASIC, a CFD is a “leveraged ‘derivative’ financial product”.

CFDs allow you to bet on rises and falls in shares, currency and other assets while only putting up a small amount of your own money. You are leveraging off the money you do have, in the hope of making more.”

However, ASIC warns, there are risks. 

“Because you are trading with leverage, the gains and losses are magnified—and the risks are much greater. You can end up losing much more than you put in.”

A position can be taken in rising and falling markets. If you buy a CFD expecting share prices to rise, this is called a long (bought) position. If the share price falls, the trader would make a loss. If the trader buys a CFD expecting share prices fall, this is called a short (sold) position. If the share price rises, the trader would make a loss.

2. Where can they be purchased?

CFDs can provide exposure to shares, indices, commodities and currencies. CFDs are offered ‘over the counter’ or through the ASX.

The ASX says their listed CFDs “offer added protection because they are the only CFDs listed, traded and cleared on the ASX providing a fully regulated and transparent market”.

According to ASIC, ASX exchange-traded CFDs have a “much lower level of counterparty risk” compared with over-the-counter CFDs as the ASX’s clearing house, ASX Clear, acts as the counterparty to trades, “so both the buyer and the seller contract with the clearing house and not directly with each other.”

Whether looking at an over-the-counter CFD or ASX CFD, ensure you research and understand the risks involved.

CFDs can be bought through CFD brokers. ASX exchange traded CFDs are only traded through brokers who have authorization to trade these types of CFDs.

3. How they work

CFDs allow traders to trade on rises and falls in share prices, indices and so on without the trader having to own them.

People like CFDs because you can trade shares and other financial products with a lower outlay and cost than say buying the actual shares,” says Switzer.

With stocks, for example, two parties agree to exchange the difference between the opening price and closing price of a stock.

Switzer says they allow a trader to hold more value than they contribute. A trader could get into a CFD for five to 10 per cent of the share price at the time they take the position. For CFDs over market indexes, it could be as small as one per cent of their value.

“As CFDs are simply contracts between a trader and a brokerage company, relating to the value of an underlying asset, the traders never have to have access to the actual exchange they are trading on. There’s no stamp duty but if you hold a long CFD position on a company at the time of a dividend payout, you get the dividend. You do receive the benefits of actually owning the stock.”

4. Do your research

Before delving into the world of CFD trading, it is crucial to do your research first. Read up as much as you can about this instrument and understand the risks involved. Check ASIC’s website for further information about the risks of CFD trading.

While CFD trading may be able to boost your wealth if things go right, you can also lose. This is the substantial risk traders take with CFD trading.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

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Published on: Monday, January 24, 2011

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