A CFD is a Contract agreed between you and your broker to exchange, at the closing of the contract, the Difference in price between the opening and closing price of the underlying instrument.
This means that in CFD dealing, you do not physically buy or hold the underlying asset; you trade a contract whose value captures every change of the price of the underlying asset.
HOW DOES A CFD WORK?
CFDs are dealt on a margin basis and you secure the transaction by paying a deposit. This means that when you open a position, you do not have to pay for its full value. Instead, you put up a deposit from 1% to 2% (depending on the contract’s margin requirement), which enables you to trade up to 100 times your initial capital (leverage of up to 100:1).You are required to keep funds in your account to cover the transaction amount of each CFD and any associated costs if the price moves unfavorably. The margin requirement must be maintained to keep your position open. Should the equity value of the account drop below the minimum margin requirement, additional funds must be added.
- Trading and Pricing CFDs are traded in units that vary depending on the CFD itself. For example:
- Oil is traded in barrels (bbl)
- Wheat is traded in bushels (bu)
- Coffee is traded in pounds (lb)
All units are set to a standardized quantity known as a “lot”. A lot represents the minimum quantity, which can be traded in any given instrument.
CFDs are quoted as seen in the underlying market. So for example, stock indices and commodities are quoted and traded in their base currency. The FTSE100 CFD is quoted in Pounds and the S&P500 in Dollars.
- Overnight Interest adjustmentsWhen you leave a CFD position opened overnight, you pay or receive daily interest adjustments depending on whether you have a long or a short position. These adjustments represent the financing fees for forex broker to maintain your position opened.The forex broker Financing Charge is 1.5% and overnight interest adjustments are calculated in accordance with the following formula:
Overnight rollover = (Interest Rate Differential – Financing Charge)/36000 x Base Value x Units per Lot x Relevant Exchange Rate.
- Expiration of underlying instrument (Roll Overs)Unless otherwise specified, the underlying instrument of a CFD has an expiration date. However, you should be aware that CFDs are not traded up until the exact expiration date of the underlying instrument. Instead, CFDs are rolled over to the next underlying Future Price during the last weekend (before the official expiration day). This is known as the expiration rollover.If there would be any substantial price difference between the two Futures, an adjustment will be Credited or Debited from the balance of your account subject to the open position amount of the expiring CFD. This Adjustment will show up in your account under Rollover Charge and will not affect the real value of your Equity.
However, you should be aware that the switch between the two Future prices of the underlying CFD could involve a substantial price difference. Therefore, Entry Orders might be filled on Market rates rather then on the predefined rates.
If you do not want to incur the price adjustment or any implication of the underlying CFD rollover, you can close your position(s) and/or cancel Orders before the rollover date and open a new position afterwards. Forex broker, at its best effort, will inform customers about any projected expiration of instruments by Popup, email, or through the site.
Forex broker Client’s Account is long 10 Dax 30 Futures CFDs at 5,700.
The price of the current Dax 30 Futures CFD (Expiry Dec 09) is EUR 5,710, making the client a profit of EUR 100 (10 lots x EUR 10).
The price of the next contract (Expiry March 10) is EUR 5,720, i.e. + EUR 10 over current month.
When Forex broker roll over to the next month’s contract:
The price feed is changed to new contract; the client’s open position will now show a profit of EUR 200 (10 lots x [5,720-5,700]).
But the Client’s Account will be debited EUR 100 to compensate for changes in P/L due to the roll.
The net financial effect of the roll-over is zero.