How do CFDs really work?

[RobinHood]

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).

 

[RobinHood]

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).

 

[korrupt_1]

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.

 

[Aussiest]

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.

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

2. Get paid FULL dividends on the ex-div date immediately.

Yes, but 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.

5. Can short the stock as easily as if you are going long.

Yes, i agree with this.

The only disadvantage I see is:

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

3. And don't forget, don't leverage yourself so you have no cash to cover the variation margin.

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.

That is true, but i think people forget about that trading CFDs. I can see how newbies would be attracted by the seemingly low risk.

I think the answer is to not use all your leverage. For example, if you only have $10,000 to trade, take out a small position.

The rest you will learn. Good luck!

.........

 

[korrupt_1]

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.

 

[white_goodman]

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

 

[eric35]

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.

 

[winsonlee]

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

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 ?

 

[MichaelD]

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.

 

[eric35]

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

Good trading

 

[Trembling Hand]

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!)

 

[white_goodman]

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

 

[eric35]

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

 

[Trembling Hand]

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?

 

[eric35]

no secret, but the rum does not allow advertising

 

[Trembling Hand]

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)

 

[winsonlee]

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 ?

 

[Aussiest]

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

 

[freddy2]

"How do CFDs really work?"

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

 

[winsonlee]

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 ?