How do CFDs really work?

[codyheit]

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?

 

[So_Cynical]

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.

 

[codyheit]

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?

 

[So_Cynical]

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.

 

[Trembling Hand]

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.

 

[xtanda]

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

 

[So_Cynical]

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

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.

 

[Trembling Hand]

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.

 

[SGB]

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

 

[Fab]

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.

 

[BigJohnny]

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

 

[trishan9390]

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.

 

[trishan9390]

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

 

[kyacct]

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.

 

[acouch]

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

 

[AlexanderPop]

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

 

[Aussiest]

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.

 

[Aussiest]

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?

 

[Aussiest]

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.

 

[robots]

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