# How do CFDs really work?



## codyheit (27 September 2007)

Hi Everyone

Ok I have been learning about CFDs of late and understand the basic principle:

CFDs 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.

I also understand the difference between Direct Mark Access brokers and Market Makers.

So before I start trading CFDs I have been doing paper based trading using the live ASX prices like a DMA CFD provider would offer.

So far I have found it very easy to predict the direction of stocks. This may be because the market is very one directional of late.

So the question I ask is what is the catch. I understand the potential risk is high for CFDs and this is why the potential for profit is so high but what I don't understand is where all the profits are coming from.

Can anyone help answer this question for me?


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## So_Cynical (27 September 2007)

codyheit said:


> So the question I ask is what is the catch. I understand the potential risk is high for CFDs and this is why the potential for profit is so high but what I don't understand is where all the profits are coming from.
> 
> Can anyone help answer this question for me?




Ive got the same question..and thats why I'm waiting for the SAX traded 
CFDs to start...cos (i believe) they will be backed by real market purchases.

So when u buy 9000 shares in xyz, the CFD provider will have to buy 
9000 shares in xyz....or something like that.

ATM i assume that the CFD providers are like bookies and simply lay 
off *bets* with other providers...the moneys gota 
be coming from somewhere.


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## codyheit (27 September 2007)

So_Cynical said:


> So when u buy 9000 shares in xyz, the CFD provider will have to buy 9000 shares in xyz....or something like that.




So it will be like trading shares on the market but with a lower buy and sell trading fee and leverage?


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## So_Cynical (28 September 2007)

Yep i think so, just the ASX CFDs will be more expensive than the current crop...but theres more depth to them as well.

so u only get what u pay for.


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## Trembling Hand (28 September 2007)

codyheit said:


> So the question I ask is what is the catch. I understand the potential risk is high for CFDs and this is why the potential for profit is so high but what I don't understand is where all the profits are coming from.
> 
> Can anyone help answer this question for me?




There is nothing out there that is easy to trade. When you add huge leverage to it it just becomes even harder.


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## xtanda (2 October 2007)

Here is how the CFD provider make money:

Say, your capital is $10k, with CFD margin 10%, so you can 'shop' for $100k worth of share. Assume you want to buy XZY Ltd share at $20 a share, hence you can buy 5000 shares of XYZ Ltd. Also let say you, hold the position for 90 days.

For long position (expecting upturn):
You will need to pay the margin interest: interest rate + "hair cut"
Say the "hair cut" is 3%, then you need to pay 6.5%+3%=9.5% for 90 days:
Interest: 9.5% x $100000(not $90k) x 90/365 = $2342
(Quick money with solid collateral , they hold the share which is very liquid and anything happen to the price you are the one who pay it - so for CFD provider this is a kind investment that very very safe with good money better than mortgage)

For short position (expecting downturn):
You will be given: interest rate - "hair cut"
Say you hold short position for 90 days, you will be given:
(9.5%-3%) x $100000 x 90 /365 = $1602
(CFD provider has $100000 cash from the proceed and they keep them as long as your position hold - "free money" that they can make them to work !)

CFD provider will pass on the dividend given by company (usually on ex date not on pay date - at least my provider do that - so faster dividend money than if you hold ordinary share), but you will not have the franked credit - they will enjoy the franked credit. Be careful when you hold short position and it is dividend time, you will the one pay the dividend to the owner of stock that you "borrow"

Hope this helps


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## So_Cynical (2 October 2007)

xtanda said:


> Here is how the CFD provider make money:
> 
> Say, your capital is $10k, with CFD margin 10%, so you can 'shop' for $100k worth of share. Assume you want to buy XZY Ltd share at $20 a share, hence you can buy 5000 shares of XYZ Ltd. Also let say you, hold the position for 90 days.
> 
> ...




So your saying that the provider is forced by law to buy the "share"
thats relevant to the CFD?....i didn't see that in any literature provided
by the CFD providers.


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## Trembling Hand (2 October 2007)

So_Cynical said:


> So your saying that the provider is forced by law to buy the "share"
> thats relevant to the CFD?....i didn't see that in any literature provided
> by the CFD providers.




No they *MAY *hedge against portions of their customers in many ways one being buying the stock that they sold to you but they are mostly trading risk similar to an insurance company. In the simplest form they are taking the other side of your trade and with large leverage expect you to lose.


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## SGB (2 October 2007)

Hi Guys,

I'm also looking at other investment vehicles to trade in and I'm currently scoping this tool (CFD)as well.
CMC Markets are one provider I am currently looking into as my provider for the CFD markets. 
Are there any other providers that you would recommend?

Thanks
SGB


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## Fab (2 October 2007)

If you are looking at CFD you might be interested in looking at Mini from ABN Amro. They are very similar to warrants and CFDs. No time decay, interest calculated only on the strike price(ammount borrowed). 3% commission on a call and 3% credited to you on a put. Look at it as I find them better than CFDs. Also you don't get dividend.


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## BigJohnny (2 October 2007)

I personally use IGMarkets, but their platform can be unstable at times. And they may run maintenance over instruments during trading hours. I stick with them, as they seem to provide a wider range of small cap resource stocks. 

Also Macquarie recently introduced their Macquarie Prime CFD wrap service. I have not tested them out yet, so cannot recommend. 

The ASX also have their own CFD product, which should start in Oct/Nov07. The start date has been pushed back twice from the original Aug07 start. Like options, there will be market-makers in certain stocks providing liquidity and spreads. Comsec have pretty decent handbook on CFD mechanics as well. http://www.comsec.com.au/Public/InvestIn/PDFs/UnderstandingASXCFDS.pdf


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## trishan9390 (2 October 2007)

I use Macquarie Prime for CFD trading. Opening the account was quick and easy and they are very helpful over the phone. 

You can trade both CFDs and Shares from the same trading platform. Interest on any unused cash is 6.5% (better than Com Bank Netsaver). DMA and minimum fees of $10. 

Some drawbacks are slow to update account summaries. Can't short on certain shares (including MBL - no suprise). Collateral rates are average.

Haven't tried withdrawing any money from my account just yet, so will let you all know how it goes when I do.


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## trishan9390 (4 October 2007)

Got annoyed with Prime today. Wanted to short MAP and couldn't!!! Another drawback is that you can't trade indices.


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## kyacct (24 July 2008)

Fab said:


> If you are looking at CFD you might be interested in looking at Mini from ABN Amro. They are very similar to warrants and CFDs. No time decay, interest calculated only on the strike price(ammount borrowed). 3% commission on a call and 3% credited to you on a put. Look at it as I find them better than CFDs. Also you don't get dividend.





Thanks Fab. E mini sounds great; especially the no dividend component. When I was trading CFD, one day, I was suddenly hit with a massive ex-dividend adjustment! Which broker would you recommend? I was with GFT. I had too many terrible times with them. Very unreliable.


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## acouch (25 July 2008)

good morning all,
today's road map
have a great day, and good trades
ac


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## AlexanderPop (27 July 2008)

CMC are good in term of products on offer and margins...but they are a dodgy with requotes and stops


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## Aussiest (27 July 2008)

I am new to all of this, but i have been giving CFDs a think.

First, be aware that at the end of each trading day, your CFD provider will debit or credit your bank account with a variation margin. This is in terms of the real dollar value of each share you buy in the CFD. Look at the 'product disclosure statement', page 29, on the MF Global website. It's a good example.

The important thing, IMO, is that you have enough money in your account to cover the variation margin. If you have a long position and the price keeps going down, and you do not sell, you will need to pay the variation margin from your cash account. If you can't do this, i am assuming the provider will close down your position, which means you will lose.

CFDs prey on people who want to enter the market with little funds. So, people with small cash holdings are naturally attracted to CFDs. Where they get caught up is if they are forced to sell out an open position due to not having enough cash to cover the variation margin.

You are also paying interest on the non-margin amount each time you hold a CFD over night. This can become expensive if you over-buy, or hold on to a losing position for too long. 

So, really, CFDs are too good to be true, if you are not aware of the variation margin (which they don't highlight in the ads) and interest.

I would hesitate until you have learned about the traditional share market, money management and stop-losses.


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## Aussiest (27 July 2008)

trishan9390 said:


> Got annoyed with Prime today. Wanted to short MAP and couldn't!!! Another drawback is that you can't trade indices.





Hi Trishan,

I am signing up for Prime too.

It's been a tough choice between Comsec and Prime, but Prime seems more flexible and slightly cheaper. The only drawback is that you can't trade MQG with them, as far as i know. I know you definately can't short MQG... So, what i am going to do is open up an account with another provider, with a small cash account, and trade only MQG through them.

It is not uncommon for an institution to ban trading of their own share or CFD. Comsec will not allow you to go short CBA, and you can't hold CBA shares as security against a margin loan.

Really annoying, but what can you do?! Work around it.

PS. How are you finding Prime apart from the MAP mishap?


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## Aussiest (27 July 2008)

Oh yeah, to the OP, be careful which broker you use. There was an article in The Age which stated if the broker goes under, you're likely to be stuck with your CFDs.  Apparently, MF Global has had some bad press as of late.


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## robots (27 July 2008)

Trembling Hand said:


> No they *MAY *hedge against portions of their customers in many ways one being buying the stock that they sold to you but they are mostly trading risk similar to an insurance company. *In the* *simplest form they are taking the other side of your trade and with large leverage expect you to lose*.




hello,

yes, one big betting shop with a PDS running over 100 pages 

if you "win" then best move is to take it and run,

why would they buy the stock they sold you, the net position would be same as you except interest

thankyou
robots


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## RobinHood (27 July 2008)

Involving yourself with CFDs is silly, unless you plan on gambling or using them for the streaming charts.

I opened a CMC account to experiment with their CFD futures, but knowing what I now know, I would have been much better off buying quality intraday data and a simulator.
Afterwards I could begin to trade with a real broker when my equity was suited risk-wise to the respective contract. 

A side note: I think simulated trading is not taken as seriously as it should be.


Why CFDs suck:
Commissions are more than a massacre. I don't see the point of trading 1 aussie200 CFD either, might as well papertrade. Why pay $4 or $8 round-trip for papertrading?

CMC will create "virtual currencies" in your account so when you set up a trade against them in a "foreign" instrument your closed position will be a "foreign" currency cash balance. Here they take money off you for converting back to "AUD", which will very soon go back to some other currency once you trade again. All this is just laughable. As if they're actually "converting" your cash, and same goes for interest -as if your actually "borrowing" from them.


There may be one useful thing about them, and that depends on the definition of "Exclusive access to CMC Markets’ Daily Trade Flow Report" (I'm wondering if it means access to data on what all CMC clients globally are doing. This would be a great crowd to track for probably the most accurate contrarian indicator).


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## RobinHood (27 July 2008)

Oh and if your planning on gambling they will not call you should you go into negative territory, they will prob wait until you owe them a few grand. 

I actually asked them whether they can call you, but they said 'We try, but sometimes we are unable to' (I paraphrased here - I guess there is a reason you can't copy whats in the client service window). They will email you though, so worst case you'll only owe them a few grand when you find out at the end of the day (if you check your emails).


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## korrupt_1 (27 July 2008)

If you understand how to use CFD properly, it is an invaluable trading instrument.

For example, I have $10,000 cash - I could...

a) Buy $10,000 of fully paid ordinary (FPO) stocks and own them outright.

or

b) Buy that same $10,000 of stocks through CFD - but only put out a margin of $500 (for a 10% margin stock) and still own the same number of shares. 

Why is option b) better?

1. Only committed $500 of capital... the remaining $9,500 (less some brokerage) can sit happily in a high interest earning savings account.
2. Get paid FULL dividends on the ex-div date immediately.
3. Pay more or less the same brokerage as option a)
4. Trade through the DMA model. No MM are manipulating prices.
5. Can short the stock as easily as if you are going long.

The only disadvantage I see is:

1. Paying overnight interest on $10,000
2. Not really having ownership of the stock

If the stock falls,.. yes you will have to inject funds to cover the margin... but the max you could lose is no different to what you could have lost through owning the FPO.

Another way that I used CFD was the ability to hedge myself againts falls in the stocks. For various reasons as to why I don't want to close out my FPO stocks position - (eg want to own the stock for full 12months to minimise CGT, etc)... I could use very little funds to short the stock and protect my open FPO position. For around 10% (depending on the margin req'd) I could open a short position of equal size to my FPO. All the while, I would be earning interest. Note that if it goes ex-div, I'm going to PAY dividend - but the nett effect should be $0 as you'll be paid divy on your FPO position. If you are smart, you could close off your CFD hedge before the ex-div date to avoid paying the divy.

One of the reason to why people think CFD are dangerous is that they are OVER LEVERAGED. If you have a trading portfolio of $50,000 cash... just trade to the maximum of the leverage of $50,000 and you'll be safe... Just because you can leverage,.. doesn't mean you should be using your $50K to control $500,000 of stocks. 

However, if you are going to be using CFD as a leverage tool, then RISK and CAPITAL MANAGEMENT is the KEY to surving it. Sure you can try to control $500,000 of stocks,.. but just remember to have a trading plan - especially when things go bad - you'll know EXACTLY how much you will be losing.


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## Aussiest (28 July 2008)

korrupt_1 said:


> Why is option b) better?
> 
> 1. Only committed $500 of capital... the remaining $9,500 (less some brokerage) can sit happily in a high interest earning savings account.
> 
> ...




.........


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## korrupt_1 (29 July 2008)

Aussiest said:
			
		

> But, won't the variation margin be subtracted from this?



Yes... BUT,.. you've only commiited the initial $500. You still have that $9,500 ready to inject in.



> ... the price usually goes down after dividend, so if you don't have enough in your cash account (considering you are going long), you may be forced to sell out the position, which could result in a loss.




Why would you not have enough cash in your account? You still have that $9,500 remember? Just remember to keep enough reserve cash in the CFD a/c. Anyway, the CFD provider will *usually* call you and let you know you are margined before they close you out.


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## white_goodman (29 July 2008)

would it be preferable to get a margin loan as ooposed to using CFD?


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## eric35 (7 August 2008)

I find trading CFD profitable, however beware!! You must watch leverage (if any) and stick to your stop losses.

As well as that, I prefer to trade with a broker who has direct market access.


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## winsonlee (19 August 2008)

xtanda said:


> Here is how the CFD provider make money:
> 
> Say, your capital is $10k, with CFD margin 10%, so you can 'shop' for $100k worth of share. Assume you want to buy XZY Ltd share at $20 a share, hence you can buy 5000 shares of XYZ Ltd. Also let say you, hold the position for 90 days.
> 
> ...




I do not understand why interest is calculated base on $100k and not $90k ?
The lending is base on $90,000 and the $10,000 is your capital isn't ?


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## MichaelD (19 August 2008)

winsonlee said:


> I do not understand why interest is calculated base on $100k and not $90k ?
> The lending is base on $90,000 and the $10,000 is your capital isn't ?




'cause that's the way CFD providers play the game. It's even more annoying if you're trading something which requires 75% margin and your paying interest on YOUR 75% as well as their 25%.

Still, 'tis what is agreed to in the PDS when you sign up.


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## eric35 (19 August 2008)

any capital in your account that is NOT taken up by margin gets interest credited to you

Good trading


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## Trembling Hand (19 August 2008)

eric35 said:


> any capital in your account that is NOT taken up by margin gets interest credited to you
> 
> Good trading



What CFD provider pays interest on capital? (if that is what you meant!)


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## white_goodman (19 August 2008)

Trembling Hand said:


> What CFD provider pays interest on capital? (if that is what you meant!)




i thought it jsut sits there and you have to transfer that money to an interest bearing account like ING savings maximiser


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## eric35 (19 August 2008)

who are you trading with? Send me an email and I tell u a good one


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## Trembling Hand (19 August 2008)

eric35 said:


> who are you trading with? Send me an email and I tell u a good one




IB but they are not bucket shop CFDs.

Just post it here what is the secret?


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## eric35 (19 August 2008)

no secret, but the rum does not allow advertising


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## Trembling Hand (19 August 2008)

eric35 said:


> no secret, but the rum does not allow advertising






My advice is if you have real capital open an account with IB and get real interest. Other wise its probably not going to matter, 7% of next to nothing is nothing. CFDs provide nothing other than too much leverage over a real broker. (possibly a bigger short list I will concede)


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## winsonlee (20 August 2008)

21 July - ABC Closing price at $20.00
22 July - ABC Closing price at $22.00

Purchase unit 10,000 unit on 21 July = $200,000. Margin 5%

Cash in account = $30,000

So after my purchase 
Cash in account = $20,000

22 July - Cash in account = $39,000 - ($220,000 x 9.25%/ 365 ) Interest

Am i right ?

So the more the share increase the more money you will have in your account although you have not sell the share yet ?


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## Aussiest (20 August 2008)

Yes. But, if the price declines, they will take money from your account... Don't forget that.


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## freddy2 (20 August 2008)

"How do CFDs really work?"

CFD money flow:
Your bank account --> Your CFD account --> CFD broker's bank account --> CFD broker's luxury yacht


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## winsonlee (20 August 2008)

If the share price is US10.00 and i purchase 10,000 unit, total cost will be US100,000. If the margin rate is at 5%, that means i need to convert AU to US 5,000 ? Do I need to maintain any $$ in US currency for the fluctuation of the share or all the remaining $$ can be in AU currency ?


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## Trembling Hand (21 August 2008)

No the CFD broker will do all the conversions. The only thing you will have to convert is the P or L after the trade is finished. That stays in the currency of the trade until converted by you back to the base AUD.


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## winsonlee (21 August 2008)

Trembling Hand said:


> No the CFD broker will do all the conversions. The only thing you will have to convert is the P or L after the trade is finished. That stays in the currency of the trade until converted by you back to the base AUD.




When you mention when the trade is finish is when i sells the share ?

I still dont quite get it. If the 5% margin is US 5,000, i have to convert AU to US 5,000. Losses and interest is deducted from my trading account in AU currency ? Do I only have trading account in AU currency or I will have trading account in US currency as well ? If I only trade in US, can I maintain my spare cash in AU currency or I need to maintain my spare cash in US currency as well ?


it will be easier if I describe a situation by using an example

Cash in trading account AU 10,000
21 Aug 2008 - Purchase XYZ share at US 10.00 for 10,000 unit. With margin lending of 5%. So I will need to convert AU to US 5,000. Assume conversion rate from au to us is 0.875. So I will need to convert AU 5,714 -> US 5,000.

Remaining cash in trading account AU 4,285

The next day I am still holding on the share and it drops US 0.10. Conversion rate is 0.875. Interest rate is 4%. Closing price for the share is US 9.90. So CFD broker will convert AU 1,142-> US1,000 to cover the losses. Daily interest calculated upon 4% of US100,000 is US 10.95. So CFD broker will convert AU 12.52 -> US 10.95 from my account to pay for the interest ?

So my closing position in my trading account is AU 4285 - AU 1142 - AU 12.52 ?


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## Trembling Hand (21 August 2008)

You don't have to do anything other than press the buy and sell buttons.

The brokers software automatically converts it for the transactions. All you have to worry about is having enough $$ in total to cover the margin.

The only thing that you have to worry about is once the trade is closed out any profit or loss will be left in the other currency. In this case USD. So at some stage you will have to ask the broker to convert it back to AUD.

Other than that it is all automatic. And market to market each day.


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## winsonlee (21 August 2008)

Trembling Hand said:


> You don't have to do anything other than press the buy and sell buttons.
> 
> The brokers software automatically converts it for the transactions. All you have to worry about is having enough $$ in total to cover the margin.
> 
> ...




when you mention "once the trade is closed", does it mean that when the market is close or it actually means that when i sell the share ?


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## Trembling Hand (21 August 2008)

when you sell


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## lasty (21 August 2008)

winsonlee said:


> If the share price is US10.00 and i purchase 10,000 unit, total cost will be US100,000. If the margin rate is at 5%, that means i need to convert AU to US 5,000 ? Do I need to maintain any $$ in US currency for the fluctuation of the share or all the remaining $$ can be in AU currency ?




They will convert it for you.
Its a paper trade.


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## winsonlee (21 August 2008)

Trembling Hand said:


> when you sell




Since at any point of time you only maintain 5% of the margin of the current share price, does that mean that when you sell only 5% of the total cost of the share will be in USD and the rest will be in AUD ?


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## Trembling Hand (21 August 2008)

NO!!!!!

I will say it again. Only the *profit or loss* from a closed out trade stays in the other currency!!


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## nat55 (31 May 2011)

kyacct said:


> Thanks Fab. E mini sounds great; especially the no dividend component. When I was trading CFD, one day, I was suddenly hit with a massive ex-dividend adjustment! Which broker would you recommend? I was with GFT. I had too many terrible times with them. Very unreliable.




Is anyone aware of other brokers who offer CFDs with no dividend ?  i.e. just marketindex CFds


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