Understanding Contracts for Difference

Contracts for Difference (CFDs) are a popular financial derivative that allow investors to speculate on the price movements of assets such as shares, commodities, and ETFs. It’s like predicting whether an asset’s price will rise or fall. 

How CFDs Work

Instead of buying or selling the asset itself, you enter a contract with a broker to exchange the difference in the asset's price from when you open the trade to when you close it. This way, your profit or loss depends on the asset’s price change.

Example: If you buy a CFD on a mining share priced at R100 and it rises to R120, your profit would be the R20 difference, without the need to own the actual share itself. If the share falls, the difference would represent a loss.

Advantages of Investing in CFDs

CFDs offer benefits that make them ideal for investors looking to diversify or hedge:

1. Fractional Shares

CFDs offer access to fractional shares, meaning you can buy a portion of a stock or asset rather than the entire unit. This makes investing more accessible, especially for high-priced stocks, and allows for more flexible portfolio allocation.

Example: If a single share costs $3 500, through BROKSTOCK you could buy 0.1 lots of the share via share CFDs for $350. This lets you participate in share price movements with a smaller initial investment, making high-priced shares more accessible.

2. Dividend Payouts

If the underlying asset pays dividends, the CFD holder will receive a dividend-adjusted payout on long positions. However, if you hold a short position, you will be required to pay an amount equivalent to the dividends to the holder of the CFD position.

Example: On BROKSTOCK, if you hold a long position on a share CFD that declares a R5 per share dividend, you’ll receive an amount proportional to your CFD position. If you short a CFD, you’ll pay that amount.

3. Access to Various Markets

CFDs offer access to a broad range of markets, including shares, indices, commodities, forex, and ETFs, all in one platform. This enables you to diversify your trading without the need for different accounts for each asset class.

Example: With BROKSTOCK, you can create a diversified portfolio by trading share CFDs, ETFs, forex pairs, and commodities all from one account.

4. Flexibility in Trading Both Long and Short Positions

You can profit from both rising and falling market movements. Taking a long position or buying allows you to profit if the price rises while going short or selling lets you gain from price declines.

Example: Let’s say you expect a company's share to decline due to poor earnings. With BROKSTOCK, you can short the CFD and profit if the share falls, allowing you to capitalise on downward trends as well as upward movements.

5. Lower Transaction Costs

CFDs come with lower transaction costs since you’re not buying the asset itself. This can reduce entry and exit fees compared to trading the asset directly.

Example: If you open a CFD position on a JSE-listed company valued at R10 000 with 0.1% commission, you would pay R10 commission to open and another R10 to close the trade, totaling R20 for the position.

6. Leverage

CFDs allow you to trade with leverage, letting you control larger positions with a smaller initial investment. However, leverage also increases the risk of running huge losses.

Example: With a 5:1 leverage, a R10 000 investment could control R50 000 worth of gold. A 5% price increase could yield R2 500 in profit but a 5% drop would mean a R2 500 loss.

Important Considerations

CFDs are regulated financial instruments, much like stocks or other investments. They allow you to trade on price movements without owning the underlying asset, giving you flexibility and access to global markets. There’s no need to feel intimidated by a term like “leverage” – it simply means you can trade larger positions with a smaller capital base.

As with any financial instrument, understanding and managing the risks well is key. With the right strategies and relevant market information, CFDs can be rewarding investment vehicles.

Disclaimer:  

*Any opinions, views, analysis or other information provided in this article is provided by BCS Markets SA trading as BROKSTOCK as general market commentary and should not be viewed as advice according to the FAIS Act of 2002. BCS Markets SA does not warrant the correctness, accuracy, timeliness, reliability or completeness of any information provided by third parties. You must rely upon your judgement in all aspects of your investment decisions and all decisions are made at your own risk. BCS Markets SA and any of its employees shall not be responsible for and will not accept any liability for any direct or indirect loss including without limitation any loss of profit which may arise directly or indirectly from use of the market commentary. The content contained within the article is subject to change at any time without notice. BCS Markets SA is an authorised financial services provider FSP No. 51404.

** This article was prepared by BROKSTOCK analyst Maboko Seabi