The Advantages of CFDs in the UK - dummies

By David Stevenson

CFDs are incredibly popular with many mainstream investors, especially those who deal in smaller company shares and more exotic markets. CFDs make great sense some of the time:

  • They’re traded on margin so you can maximise your trading capital.

  • They incur no stamp duty (saving 0.5 per cent compared to a traditional share purchase).

  • They represent tax-efficient trading. If you have a holding of physical shares you can sell CFDs against this holding without crystallising a potentially taxable capital gain. Therefore, you can control the time at which you realise capital gains or losses and perhaps reduce your tax liability.

  • They allow you to profit from falling or rising markets by trading long or short.

  • They give you access to a great range of financial markets through a single account.

  • They help limit and manage your risk using stop losses and limit orders as for spread bets. Make sure that the limit order is one that’s executed at a better price than the prevailing market price; that is, for a long CFD trade when the stock drops to a certain level or for a short CFD trade when the stock rises to a certain level.

Using CFDs works well as part of a number of different trading strategies:

  • Short-term trading: The ability to gear up your trading capital by trading on a margin combined with no stamp duty make CFDs a useful instrument for short-term trading.

  • Hedging: You can use a CFD to protect your long-term holdings against variable market conditions. Opening a short CFD position in the shares may be cheaper than selling the physical shares in order to buy them back later.

  • Pairs trading: If you believe that one company is undervalued compared to another company (for example, Barclays against Lloyds), you can use CFDs to go long on the cheaper stock while going short on the more expensive stock.