Understanding CFDsTHE CMC MARKETS TRADING SMART SERIES

CMC Markets | Understanding CFDs 2

CFDs, or contracts for difference, have taken their place among other derivatives such as options in the toolkit of traders around the country. Their flexibility 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 shouldn’t forget that CFDs are a leveraged product which carries significant 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.

Proudly No. 1 for CFD education Results from Investment Trends September 2010 Singapore CFD Report, based on ratings given by 8,900 investors

CMC Markets | Understanding CFDs 3

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 don’t 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.

Aspects of CFD tradingCFD trading has distinct features that distinguish it from share

trading, even though it may appeal to traders and investors alike.

LeverageIn the financial 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 financial 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 10–20% 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 profit or loss as if you funded the entire

value of the CFD position you are dealing in.

Using margin increases the opportunity to profit 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, it’s important to be aware that trading on margin is

a double-edged sword, because it magnifies both potential profit

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 can’t 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.

Flexibility

Two attractive features of CFDs are low transaction costs and

low margins, but they are not the whole picture. CFDs’ flexibility is

another key feature. CFDs allow you to benefit 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 profit is

the difference between the two. This enables you to benefit 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 flow, or apply fundamental analysis.

While not always the case, traders generally will not want to have

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.

CMC Markets | Understanding CFDs 4

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 it’s

best not to focus exclusively in that direction. Even if the market has

been consistently bearish for some time, if you’re too heavily short at

the wrong time you could easily suffer some significant 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 all-

important component of survival for traders.

CFDs can be traded long or shortWhen you buy a CFD (go long), you’re expecting its price to go up so

you can sell it later at a higher price, for a profit. When you sell a CFD

(go short), you’re expecting its price to go down so that you can buy it

back later at a lower price, for a profit. 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.

Dividends and corporate actionsFor 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 reflecting 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

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 reflected with a cash adjustment on your CFD account

as soon as they’re implemented.

Reporting seasonThe 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 profit guidance for upcoming periods and when analysts and

investors reassess their own forecasts. Depending on a company’s

performance and projected profit, 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 profit 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

reflected 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.

Product trading timesWith 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:

uCurrencies, covering over 70 different currency pairs from

developed and emerging markets

uCommodities, including agricultural, precious metals, industrial

metals and energy

uGlobal indices, covering most regions including the Hong Kong

43, US30 and Japan225

uCompanies, from across the globe – you don’t 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 time-

management advantage for busy traders who may be working full

time while the local markets are open.

CMC Markets | Understanding CFDs 5

Fractional ownershipYou 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 specific 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.

Expiry datesAnother 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.

Transaction costsThe 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.

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

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 don’t

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.

Borrowing cost = (Total position value - Margin) x Borrowing rate

365

NB Borrowing costs do not apply to precious metals.

What are the carrying costs?Applies to commodity CFDs and currency CFDs only.

Investing directly in some assets carries an associated cost or

benefit 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 benefits) associated with holding that crude oil until the

delivery date. The carrying cost represents the cost involved in

holding an asset.

Carrying cost = Total position value x Carrying rate long / Carry rate short

365

NB For company CFDs and index CFDs, carrying costs do not apply.

Managing riskCFDs are speculative products that are highly leveraged and carry

significantly greater risk than non-leveraged investments such as

ordinary share trading.

CMC Markets | Understanding CFDs 6

Point of comparison CFDs Options Warrants

Traded on margin Yes – your choice No Yes

Can be traded long or short Yes Yes Yes - call/put

Dividend payment Yes No Yes – instalment warrants

Expiry date No Yes – can expire worthless Yes

Stop loss orders Yes No No

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

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 (financial, taxation and otherwise).

Our education servicesDemo 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 CFDs stack up against other derivatives?As a financial instrument, CFDs have features that may make them

attractive to both traders and investors. They also carry significant

risks.

Transfer your existing knowledge to CFDsPossibly the greatest benefit 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 marketsCFDs open up a whole new world of financial markets, including

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 financial 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 profile, derivatives (including CFDs)

may play an important part in growing your investment portfolio.

How do they fit in your investment portfolio?After learning more about CFDs and their features, you may wonder

how they fit into your investment portfolio. Perhaps you have a

healthy share portfolio that you want to keep growing.

Portfolio diversificationEven if you’re a long-term buy-and-hold investor, CFDs can be used to

take advantage of short-term profitable moves in the market without

affecting your existing investments. This means that while your long-

term positions are growing over time, you can trade CFDs to deliver

profit 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 find it better

to invest directly in commodity CFDs rather than taking a position

CMC Markets | Understanding CFDs 7

via a resource or agricultural company shares. Advantages of direct

investment via CFDs can include:

• avoiding company-specific 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

fluctuations

• being able to profit from falling prices via short selling as well as

from rising prices

Types of CFDsThere 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. Profit and loss will be

reflected 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 aren’t 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 don’t have to pay the extra

administrative charges you’d pay to trade physical shares in

overseas companies

CMC Markets | Understanding CFDs 8

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 you’re

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 significant risks and it’s possible to lose more than your

initial investment.

Q Will you get a share certificate when you trade a company CFD?

A No, you’re not actually buying stock in that company, you’re 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 platform’s 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 financing, 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 confidence,

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 LeFèvre, 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

America’s top traders

Martin Schwartz, Pit Bull: Lessons from Wall Street’s 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 Trader’s Bible

© CMC Markets Singapore Pte. Ltd., Reg. No./UEN 200605050E. All rights reserved August 2011.

cmcmarkets.com.sg

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 specific investment objectives, financial situation and particular needs of any specific 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, financial situation and particular needs and, where necessary, consult an independent financial 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 profits 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 difficulties 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.

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