Contracts for difference

Entering into a contract for difference, or CFD, involves making a bet on the movement of share prices. It works in much the same way as buying and selling shares except that there is no actual share transfer (and hence no stamp duty).

The contract itself is an agreement between two parties to exchange, at the close of the contract, the difference between the opening and closing price of a share, multiplied by the number of shares the contract specifies.

A ‘long’ CFD gives the holder all the benefits of a rise in the share price, but no rights to acquire the underlying share, and no shareholder rights. A ‘short’ CFD gives the holder the benefits of a fall in the share price, without the need to deliver the underlying shares.

On entering the CFD you deposit a percentage, say 20%, of the contract value (share price multiplied by number of shares). In this way, CFDs are used to gain leverage of up to five times exposure: a £20,000 CFD will bring the same returns as £100,000 worth of stock.

But there is also a downside. If the share price tumbles when you expect a gain, you can end up losing more than your original investment.

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