Contract For Differences (CFD) – Chapter 6: How CFD’s work

Trading with CFDs involves going Long or Short in the market position. An investor is said to be holding a long position if he purchases shares now hoping to sell them later when the price goes up and realize a gain.

Conversely, the investor is said to be holding a short position when he sells shares now and hoping to buy them back later at a lower price when the price actually falls. The difference between the price he sold at and the price he purchased the share back at will represent his profit level.

With short selling, what essentially the investor did was to “borrow” the shares from a third party to open the trade. Therefore when the investor closes his market position by buying back the shares at a cheaper price, he actually makes money from a decline in the price of the share.

The investor has the option to trade in indices or on the equity market. However, the margin required will actually vary among the different financial instruments that are available. In addition to the initial margin, other transactional costs must be taken into deliberation.

Although CFDs are not subjected to stamp duties, they are still liable for Capital Gain Tax (CGT). Any income that is derived from a closed market position will be subjected to CGT. On the upside, for losses incurred, an investor is also able to write off their losses against their gains thus reducing the actual amount of CGT payable to the Government. Not having to pay the stamp duties also allows investor to save an additional 0.5% off all transactions as compared to traditional equity trading.