How Does CFD Finance Actually Work?

CFD finance is relatively simple to understand, if you understand the whole process of trading a CFD. When you buy a Contract for Difference you are only required to provide a small margin. This margin requirement is required to cover any loss you may make on a position and changes from day to day as the value of the underlying position changes. The small margin that you pay does not cover the cost of the underlying instrument. To hedge your position the broker will buy the underlying share when you enter a position and to do this has to front up with the full purchase price. In effect the broker is lending you the cash while you hold the position open.

Buying CFDs

When you buy a CFD the broker will charge you interest on the money. The rate of interest is applied to the face value of the position, i.e. the number of contracts times the current price. So if you buy 1000 contracts of BHP at $33, then you will be required to pay interest on $33,000. This is how CFD finance works when trading long.

Selling CFDs

On the other side of the coin if you sell a CFD short you effectively receive the cash for that sale. While it does not end up in your bank account it does end up in the brokers bank account if they sell the underlying stock. So selling 1000 contracts of CBA at $33 would mean that you would receive interest on $33,000. This is how CFD finance works when trading short.

How Much Will It Cost?

Interest rates vary from provider to provider but are usually based on the following formula. A reference rate of interest plus a margin of 2 – 3% for long positions and a reference rate of interest less a margin of 2 – 3% when trading short. The reference rates used are typically the Reserve Bank of Australia (RBA) rate or the London Interbank Offered Rate (LIBOR). The broker is therefore making money on the interest margin that they take on each position. This is how CFD finance works for them and CFDs could be regarded as a sophisticated way to lend money.

How Are CFD Finance Charges Calculated?

Interest charges are calculated daily and do not apply to positions opened and closed on the same day. Intraday trades are therefore exempt from interest, while trades held overnight will incur charges. CFD finance does not apply to intraday positions. When trading CFDs the impact of finance costs is minimal as interest rates are currently at about 6% per annum while CFD positions can easily fluctuate 6% in a day.

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