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Understanding CFDs

CFDs, or contracts for difference, have taken their place among other derivatives such as options in the toolkit of traders around the country. Their exibility has led to a dramatic growth in popularity. In fact, Investment Trends research showed that there were an estimated 22,000 active CFD traders in Singapore in September 2010. However, you shouldnt forget that CFDs are a leveraged product which carries signicant risks and, despite their attractions, they must be treated with care. This guide aims to provide some of the basic information you need before you consider trading them.

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Results from Investment Trends September 2010 Singapore CFD Report, based on ratings given by 8,900 investors

CMC Markets | Understanding CFDs

Understanding CFDs
Develop a basic understanding of what CFDs are and how they work. Understand how CFDs can work in your overall portfolio. Learn about the different types of CFDs available for trading.

What are CFDs?

A contract for difference, or CFD, is an agreement between two parties to pay the difference in price of a contract between the time it is opened and the time at which it is closed. It is a derivative instrument, which means that when you trade CFDs you are trading an instrument whose price is based on an underlying asset that you may already be familiar with. These assets may include companies (or equities), commodities, indices or currencies. Importantly, CFDs are an OTC, or over-the-counter, product. This means that they are not traded on an exchange, and that when you trade with CMC Markets, we are the counterparty to the transaction. When you trade CFDs, you dont actually own the underlying asset. Instead, you are trading a contract whose value is determined in line with the value of the underlying asset. The underlying asset could be shares like Google or BHP Billiton, or it could be a commodity like gold. Our Product Library lists all tradeable CFDs. This can be found on the CMC trading platform and at cmcmarkets.com.sg/markets.

Using margin increases the opportunity to prot because you can often afford to hold larger positions than if you were funding in full. It also has the potential to increase the return on a smaller amount of funds you use to open a position. Nevertheless, its important to be aware that trading on margin is a double-edged sword, because it magnies both potential prot and potential losses. You may lose more than your initial investment when you trade CFDs. Sound risk management is essential to success for both traders and investors. This is particularly true where leverage is involved. You cant be a trader or investor without taking risk, but it is vital to take steps to limit this risk to levels that are appropriate for your circumstances. The CMC trading platform includes a customisable margin facility to assist with risk management. This puts you in control of the margin you use on each transaction. You can dial the margin up or down to anywhere from using no leverage at all to employing full leverage where you need have only the minimum margin requirement to open a new position. The extent to which you use leverage is only one aspect of a sound risk-management plan.

Aspects of CFD trading

CFD trading has distinct features that distinguish it from share trading, even though it may appeal to traders and investors alike.

Flexibility Leverage
In the nancial market, leverage means the use of borrowed money to invest in products such as property, shares, artwork, property trusts or managed funds. A common example of using leverage is borrowing money from a bank or nancial institution to invest in a residential or investment property. This loan is usually secured by a mortgage over the property. People may also borrow money to trade or invest in shares. Margin loans where the shares are used as security for the loan are commonly used for this purpose. With CFDs you can also elect to open positions without having the full value of the CFD position in your account. The amount required to open a position is known as margin. Some CFDs require as little as 2% margin, some 5%, and others 1020% or more. It depends on the CFD. For many investors and traders, being able to trade on margin using leverage is one of the biggest attractions of CFDs. When trading on margin you make the same prot or loss as if you funded the entire value of the CFD position you are dealing in. Two attractive features of CFDs are low transaction costs and low margins, but they are not the whole picture. CFDs exibility is another key feature. CFDs allow you to benet from either rising or falling prices. In other words, with CFDs you have the ability to trade on both the long side and the short side of the market. This means that you can align your trading portfolio more closely to prevailing market trends. Short selling occurs when your opening trade is a sell order. If the price falls and you close the position (with a buy order), your prot is the difference between the two. This enables you to benet directly from a fall in the price of the underlying assets such as currencies, commodities, indices or companies. The availability of short selling can allow you to better capitalise on the time you devote to market analysis. Strategies used to successfully identify buying opportunities can usually be applied to identifying selling opportunities as well. This applies whether you use technical analysis or trade news ow, or apply fundamental analysis. While not always the case, traders generally will not want to have

CMC Markets | Understanding CFDs

their trading portfolio either entirely long or entirely short. If you structure your trading portfolio entirely one way or the other, the day-to-day oscillations of the market can have a marked impact on the value of your portfolio. While portfolio volatility is easy to talk about, it becomes more of an issue when you have real capital invested. In general there are long and short opportunities regardless of the prevailing market conditions. Naturally, in a bear market there will be more opportunities on the short side than on the long side, but its best not to focus exclusively in that direction. Even if the market has been consistently bearish for some time, if youre too heavily short at the wrong time you could easily suffer some signicant drawdowns if the bear market rallies. Difference between the short-term trader and the investor: For the investor, the idea of weathering the ups and downs of being in the market is part and parcel of the business. For the short-term trader, the objective is to try and capture smaller moves of the market and then exit. Timing is an allimportant component of survival for traders.

being equal, the price of the underlying share and the company CFD will fall by the dividend amount on the ex date. On the other hand, if you have a short CFD position going into this date, the amount of the dividend will be deducted from your CFD account. Other corporate actions such as bonus issues and share splitting are also automatically reected with a cash adjustment on your CFD account as soon as theyre implemented.

Reporting season
The reporting season refers to the time of year when publicly listed companies update the market about their half-yearly and yearly performance. It is also when companies may announce their prot guidance for upcoming periods and when analysts and investors reassess their own forecasts. Depending on a companys performance and projected prot, the reporting season can result in volatility within the market. For example, if a company issues a forecast that its earnings will be lower in the next half year, the share price might fall as investors may be disappointed with this result. On the other hand, if a company unexpectedly doubles its income and prot expectation for the coming year, the share price may jump higher as investors and traders take advantage of the good news. As CFDs tend to move in line with the price of the underlying market, movement in share prices during the reporting season may also be reected in CFD prices. As a trader or investor, it pays to be aware of the possible impact of the reporting season on your CFD positions. NB Reporting seasons vary from market to market.

CFDs can be traded long or short

When you buy a CFD (go long), youre expecting its price to go up so you can sell it later at a higher price, for a prot. When you sell a CFD (go short), youre expecting its price to go down so that you can buy it back later at a lower price, for a prot. Being able to trade long or short is one of the most attractive features of CFDs. It means you can trade long with the aim of making money on a rising market, or trade short looking to make money when the market is falling. NB While you can go long or short in all currency, commodity and index CFDs, not all company CFDs can be traded short. Generally, short selling is available for CFDs over all the largest and most liquid companies. You can check whether shorting is allowed on a company CFD by consulting either the individual company overview in the Product Library on the CMC trading platform or cmcmarkets.com.sg/ markets.

Product trading times

With CFDs there are thousands of products to invest in across all the major shares and indices in the US, UK, Europe and Asia. Here is a selection of different asset classes you can invest in: u Currencies, covering over 70 different currency pairs from developed and emerging markets u Commodities, including agricultural, precious metals, industrial metals and energy u Global indices, covering most regions including the Hong Kong 43, US30 and Japan225 u Companies, from across the globe you dont have to stick with the Singapore market Some of the most popular and liquid trading instruments such as foreign exchange, share indices and major commodities trade continuously from early Monday morning through until Saturday morning Singapore time. These markets tend to be at their most active during the UK and US trading day. This can be a timemanagement advantage for busy traders who may be working full time while the local markets are open.

Dividends and corporate actions

For many long-term investors, dividends remain one of the determining factors in whether they invest in a particular share or not. Therefore, dividends can be considered important when deciding which stock to buy. When you trade company CFDs on dividend-paying shares, you will automatically be paid an amount reecting the dividend when you have a long position going into this date. The dividend payment is usually shown on your CFD account when the underlying share goes ex dividend. This is the date from which any new buyers of the stock are no longer entitled to the next dividend payment. Payment of the dividend amount compensates for the fact that, all things

CMC Markets | Understanding CFDs

Fractional ownership
You can buy and sell CFDs either by units or amount. You can also trade from as little as 1/1,000 of a unit, or a specic monetary amount. We refer to this feature of the CMC trading platform as fractional ownership, and it sets new standards in precision and effective asset allocation. It can be a good way of getting started with small trades while you become familiar with how CFD trading works. With a traditional broker, the smallest trade size in units would be 1 share or perhaps $10,000 in currencies. Using fractional ownership you could decide to invest in a half or even a tenth of a company CFD or 0.001 units in currency CFDs. It is important to remember that you do not actually own the underlying asset.

Holding costs
What are holding costs?
For each CFD position that remains open at the end of a calendar day (17:00 New York), a transaction holding cost will be calculated and applied. The transaction holding cost comprises two components: the borrowing cost, which is applied to the unfunded portion of the CFD position, and the carrying cost, which is equivalent to the cost of holding the underlying asset. The transaction holding cost is applied to the total value of the CFD position. Holding cost = Borrowing cost + Carrying cost

Expiry dates
Another aspect of CFD trading involves expiry dates, or length of holding time. Unlike some other derivatives that have expiry dates and become worthless upon expiration, CFDs do not expire. Short-term traders may trade CFDs for a few days, while medium- to long-term investors and traders may trade them over a few weeks or months.

NB If the CFD is not priced in your local currency, the current CMC Markets currency conversion rate would be applied to the holding cost total.

What are the borrowing costs?

Applies to index CFDs, company CFDs and commodity CFDs only. When you open a CFD position with CMC Markets, which you dont fully deposit as margin, a cost is applied to the value of the unfunded portion of the position. We calculate the rate applicable to the borrowing cost based on interbank lending rates. (Total position value - Margin) x Borrowing rate Borrowing cost = 365 NB Borrowing costs do not apply to precious metals.

Transaction costs
The difference between the buy and sell price quoted on our CMC trading platform represents a transaction cost. For example, say you wanted to buy the Australia 200 index when the quoted sell price was 4,570 and the quoted buy price was 4,571. If you were to buy 1 unit for 4,571 but then immediately sell at 4,570 before the price changes, you would incur a loss of $1. In other words, the price has to rise by 1 point before you can break even on the deal. In this example, you can see that the smaller the spread, the less the market needs to rise before you break even, so the less it will cost you to enter the transaction. NB For products like indices that trade 24 hours, spreads can widen when the underlying exchange is closed. There are no distinct commissions or transaction fees associated with CFDs on the CMC trading platform. We have removed these individual charges and built the cost of trading into the price quoted on screen, providing greater transparency. This will have the effect of slightly widening the spread between the buy and sell price on company instruments compared to the underlying price quoted on the exchange. NB Other charges may apply and you should refer to our Risk Warning notice and Terms of Business. All of these documents are available on our website at cmcmarkets.com.sg/legal/cfds.

What are the carrying costs?

Applies to commodity CFDs and currency CFDs only. Investing directly in some assets carries an associated cost or benet of physically holding that asset for a period of time. For instance, if you buy crude oil, there is interest, storage and seasonal costs (or benets) associated with holding that crude oil until the delivery date. The carrying cost represents the cost involved in holding an asset. Total position value x Carrying rate long / Carry rate short Carrying cost = 365 NB For company CFDs and index CFDs, carrying costs do not apply.

Managing risk
CFDs are speculative products that are highly leveraged and carry signicantly greater risk than non-leveraged investments such as ordinary share trading.

CMC Markets | Understanding CFDs

CFDs may not be suitable for all investors. It is possible to incur losses in addition to any fees and charges that apply. These losses may be far greater than the money you have deposited into your account or are required to deposit to satisfy a margin requirement. It is important that you fully understand the risks involved before trading. You should carefully read our Risk Warning notice which is available from our website at cmcmarkets.com.sg/legal/cfds. We also recommend that you seek independent advice. You should consider whether trading in CFDs is right for you given your personal circumstances (nancial, taxation and otherwise).

those in the US, UK, Europe and Asia, which have not previously been easily accessible to Singaporean traders. CMC Markets offers CFDs on international companies, indices, commodities and currencies. All nancial markets, from the most simple to the most complex, have individual features that may make them attractive or unappealing to investors. If considered properly and traded according to your personal risk prole, derivatives (including CFDs) may play an important part in growing your investment portfolio.

Our education services

Demo account. Are you new to investing and looking to try a fully functional investment and trading experience without risking your own money? Or are you an experienced investor wanting to test out new strategies in a risk-free environment? Whatever your reasons, you can get access to our unlimited demo account in less than 60 seconds. We strongly recommend that you practise using the demo account before opening a live account. Ongoing education. CMC Markets provides extensive education on charting, technical analysis and risk-management tools, all covered in our free webinars.

How do they t in your investment portfolio?

After learning more about CFDs and their features, you may wonder how they t into your investment portfolio. Perhaps you have a healthy share portfolio that you want to keep growing.

Portfolio diversication
Even if youre a long-term buy-and-hold investor, CFDs can be used to take advantage of short-term protable moves in the market without affecting your existing investments. This means that while your longterm positions are growing over time, you can trade CFDs to deliver prot from short- to medium-term trades. In order to diversify their investments, some traders maintain their share/equity portfolio for capital gains and ongoing dividend income while also pursuing a CFD portfolio for short- to medium-term investment or trading. The long-term investor is willing to ride the ups and downs of the market with a view to capturing long-term gains. However, you may be able to go quite a long way to smoothing your overall portfolio volatility by utilising short CFD positions. You can take on a short position with CFDs to cover the value of shares that you have, but this is not the only option available to you. If you consider some short-term methodologies based on technical analysis, you may be able to take on short CFD trades based on downtrending stock prices. Alternatively, if you follow a more fundamental analysis philosophy you may look for sectors of the market that will be most heavily impacted by current economic conditions. Investors with a view on commodity prices may at times nd it better to invest directly in commodity CFDs rather than taking a position

How do CFDs stack up against other derivatives?

As a nancial instrument, CFDs have features that may make them attractive to both traders and investors. They also carry signicant risks.

Transfer your existing knowledge to CFDs

Possibly the greatest benet for traders using CFDs is that their price is in line with that of the underlying reference instrument. This means that the methods of analysis you may have previously applied to products such as shares can also be applied to trading CFDs.

Exposure to international markets

CFDs open up a whole new world of nancial markets, including

Point of comparison
Traded on margin Can be traded long or short Dividend payment Expiry date Stop loss orders

CFDs
Yes your choice Yes Yes No Yes

Options
No Yes No Yes can expire worthless No

Warrants
Yes Yes - call/put Yes instalment warrants Yes No

This table is a comparison of CFDs, options and warrants that may help you understand derivative products in relation to one another.
CMC Markets | Understanding CFDs 6

via a resource or agricultural company shares. Advantages of direct investment via CFDs can include: avoiding company-specic risk, such as cost over runs on new developments, or disappointing production due to drought or other weather events participating more directly in short-term commodity price uctuations being able to prot from falling prices via short selling as well as from rising prices

Types of CFDs
There are various types of CFDs. They include company CFDs, index CFDs, currency CFDs and CFDs on commodities. You can easily access the full range of instruments via the Product Library on the CMC trading platform. When you invest in global products that are not in your local currency, funds are automatically converted at the prevailing CMC Markets exchange rate to complete the transaction. Prot and loss will be reected and settled in your local currency.

International company CFDs

In addition to Singaporean shares, CMC Markets also offers international company CFDs including US, European, UK and Asian. This means you can trade company CFDs on Google, Amazon, Walmart, Honda, Toyota, Vodafone, BMW, Porsche and other big brands that arent available in the Singapore market. Trading international company CFDs offers many advantages, including: access to bigger and more liquid markets with more trading opportunities than those available locally low transaction fees, because you dont have to pay the extra administrative charges youd pay to trade physical shares in overseas companies

CMC Markets | Understanding CFDs

FAQs
Q What do the letters CFD stand for? What are you actually trading when you trade CFDs? A CFD is short for contracts for difference. When trading CFDs youre actually trading the margin of price change, or the difference in price from when you open the position until the time you close the position. Q What are the main advantages of trading CFDs? A The ability to trade both short and long, cost-effective entry into trading, low transaction costs, and the ability of CFDs to be traded on margin. However, you should remember that investing in CFDs also carries signicant risks and its possible to lose more than your initial investment. Q Will you get a share certicate when you trade a company CFD? A No, youre not actually buying stock in that company, youre only trying to capture the price movement between the time you open a CFD trade until the time you close it. Q How many CFD products are available to trade with CMC Markets? A CFDs are available on thousands of instruments, see the Product Library on the CMC trading platform or at cmcmarkets.com.sg/ markets for full details. Q Are stop loss orders applicable to CFDs? A Yes. Unlike options or warrants, you can place a stop loss order with a CFD trade. Q Are there time limits for holding a position with a CFD? A No. Unlike options or warrants you can hold a CFD trade for as long or as short a time as you choose. Q What is the approximate percentage outlay of trading CFDs compared to trading shares? A Each CFD has different minimum margin requirements, generally ranging from 2% to 20% of the price for most CFDs, With the CMC trading platforms customisable leverage facility you can dial the margin up or down to anywhere from using no leverage at all to full leverage based on the minimum margin requirement. There may be other costs to consider, including nancing, but this depends on how long you hold the CFD.

Recommended additional reading

Catherine Davey, Making Money from CFD Trading: How I turned $13k into $30k in three months Mark Douglas, Trading in the Zone: Master the market with condence, discipline and a winning attitude Curtis Faith, Way of the Turtle: The secret methods that turned ordinary people into legendary traders David Land, CFDs For Dummies Edwin LeFvre, Reminiscences of a Stock Operator Marcel Link, High Probability Trading: Take the steps to become a successful trader Jack D. Schwager, The New Market Wizards: Conversations with Americas top traders Martin Schwartz, Pit Bull: Lessons from Wall Streets champion day trader Chris Tate, The Art of Trading: A complete guide to trading the Australian markets Frank Watkins, Exploding the Myths Richard D. Wyckoff, The Day Traders Bible

CMC Markets | Understanding CFDs

The information contained herein / presentation (the Information) is provided strictly for informational purposes only and must not be reproduced, distributed or given to any person without the express permission of CMC Markets Singapore Pte. Ltd. (CMC Markets). The Information is not to be regarded as an offer, a solicitation or an invitation to deal in any investment product or an advice or a recommendation with respect to any investment product, and does not have regard to the specic investment objectives, nancial situation and particular needs of any specic person. Contracts for Difference and leveraged foreign exchange trading involve the risk of sustaining substantial losses and are not suitable for all investors. You should independently consider the Information in the light of your investment objectives, nancial situation and particular needs and, where necessary, consult an independent nancial adviser before dealing in any investment product. Risk warning/disclosures and other important information are available at our website: www.cmcmarkets.com.sg or by contacting us at + (65) 6559 6000. CMC Markets does not warrant the accuracy, completeness, suitability, currency or reliability of the Information. CMC Markets accepts no liability for loss whatsoever arising from or in connection with the use of or reliance on the Information. It should not be assumed that any product evaluation or analysis techniques presented herein, if relied upon, will guarantee prots or gains or will not lead to losses. Any graph, chart or any device set out or referred to herein / presentation possesses inherent limitations and practical difculties with respect to its use, and cannot, in and of itself, be used to assist any person to determine and/or to decide which investment product to buy or sell, or when to buy or sell them. Past performance is not necessarily indicative of future performance, result or trend. CMC Markets does not and shall not be deemed, and accepts no obligation, to provide advice or recommendation of any sort in relation to any investment product. CMC Markets may or may have expressed views different from the Information and all views expressed are subject to change without notice. CMC Markets reserves the right to act upon or use the Information at any time, including before its publication herein.

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