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Understanding CFD Trading - Part 3

Posted in Contracts for Difference CFD, Submitted by Trading Critic on Sat, 2006-04-08 06:57.

In Part 2: Understanding CFD Trading we had a look at some more basic mechanics of CFDs – Contracts For Difference such as the margin requirements for CFDs and some basic strategies that you can use when using CFDs to trade. In Part three we continue in our venture in looking at further intricacies and specifics in trading CFDs.

When you trade CFDs your position is leveraged which means you are controlling a much bigger underlying amount of value. As a consequence you either have to pay interest to maintain the position or be paid interest as a result of your position. When you have a long position – that is, when you bought into the position, you have to pay interest that is calculated and charged daily to maintain your position. On the other hand, if you have a short position – that is if you sold to enter into your position then you are credited interest. The interest rate you pay or receive is calculated to include a margin above for long CFDs or a margin below for short CFDs in addition to the going interest rate. For example, most dealers have a 2 per cent premium above the overnight cash rate; and currently in Australia (March 2006) our official cash rate is at 5.50 per cent – this means the dealer will be charging you or crediting you 7.5% per annum or 3.5% per annum respectively. So if you held a trade overnight, you would calculate the interest you’ll pay or be credited by multiplying: [Underlying value of CFD] x [Interest Rate + Premium] * 1[day] x 365 [days in one year].

Remember that CFDs allow you to short sell to make a profit if the value of the underlying equity falls. Normally, people recognize that with many things, you can make money on prices appreciating but CFDs as an instrument totally streamlines the whole short selling process. Before CFDs came along your broker would have needed to "borrow" the shares from somewhere to enable you to short a stock or other equity.

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