Reducing the Risk of Contracts for Difference

Every kind of investment carries with it some kind or amount of risk and Contracts For Difference are no exception. In fact, they could be considered as a high risk investment because you can easily lose more than you invest. However, there are ways to mitigate this risk somewhat and one particular way is to use what is known as a Stop Loss Order.

The Stop Loss Order can be set to whatever you choose. For instance you may buy cfds at $3.00 each and set the Stop Loss Order at $2.60. A stop loss order signals the cfd provider to close your position so that you do not sustain further loss. Unfortunately such stop loss orders can be slow in going through if there is a rush of like orders. And in the case of a dramatic and quick fall where liquidity is in short supply, you may still lose a great deal more than you intended. This is more of a problem on equity prices than indices and currencies that usually experience very active trading.

However you can also have what is known as a Guaranteed Stop Loss Order (GSLO), if your cfd provider offers it. You have to pay an additional charge for this benefit and there are certain restrictions imposed, but it is better than being subject to large losses if the market moves against your plan. So if you are planning to get into investing with cfds it is wise to find out all about how you can best reduce the risks inherent in such a product.

Tax Implications of Gains from Trading in CFDs

If you are trading CFDs in Australia, you obviously want to know the tax implications in regard to gains or losses that you make in the process because there is a confusion whether trading CFDs is a gambling activity or not.   

Any gains arising from gambling contracts do not qualify as assessable income/loss nor shall they be considered under capital gain or loss. The ATO holds the view that trading CFDs is not a gambling activity.

The Australian Tax Office (ATO) considers any profit made or loss incurred during the process of trading CFDs is assessable income or tax deductible as the case may be. However, the profits obtained and losses incurred must be a result of a business operation or transaction and the transaction/s must have been entered into as an ordinary part of carrying on a business. Gains from trading CFDs that do not meet these conditions qualify for tax as capital gain or loss.

This also means that while calculating capital gains arising from trading CFDs, the tax office will give due consideration to cost of acquisition and factors that apply to buying and selling assets. In the case of trading CFDs, the cost of acquisition includes the price plus charges, fees, interest or any other expense that you may incur for acquiring and holding the CFD. Similarly, the cost that you may incur for disposing of the CFD will also be considered. Similarly, any benefits such as interest, dividends or any other adjustment made to your account during the course of business of trading CFDs shall form a part of net gain.  

The above provisions apply to resident Australians. If you are a non-resident, you may want to consult a professional to know your status as well as the tax implications of trading CFDs. 

Stock Index Futures and Index Future CFDs

Index futures and/or index futures CFDs refer to a basket of top stocks traded in an exchange. Similarly, sector index CFDs refer to top stocks within a specific industry. A bank index, for example, has top banks as its constituents.

An index or sector futures contract is an agreement to buy or sell an index at a specified future date at an agreed price and a cash settlement occurs on expiry of the contract. Index futures CFDs on the other hand are not settled for cash but automatically carried over to a new date by the product provider.  

CFDs are contracts for difference and you trade in the underlying reference instrument (in the present context, an index futures contract) without actually owning it. Your trade for the price fluctuations and your profit or loss is the difference between the price when you enter and exit a position. The counterparty in CFDs is the CFD provider with whom you must complete all transactions in relation with the position you open. All closing positions must necessarily be equal and opposite of the open positions.

Index futures CFDs are derivative products just like index futures contracts but the problem with trading directly on a futures exchange is that there are standardised contracts that specify position size and expiry date. In contrast, CFDs are customised derivative products without a standard form. CFDs are also simpler to understand as they trade at the spot price with a small commission or the providers spread reflected as the difference between bid and offer quotes.

However, there is a risk involved in CFDs because they are offered over-the-counter and not regulated products. Much depends upon the credibility of the broker you choose to trade with.

Information Relevant to Treasury CFDs

CFDs are tradable instruments that mirror price movements of an underlying asset. The profit or loss you make is the difference between the price at which to open a position and the price at which you close it.  In case of treasury CFDs, the underlying reference asset is fixed income securities issued by the government and/or other bonds. A major advantage of trading treasury CFDs is that you can benefit from even extremely small price movements.

The price of most CFDs is influenced by multiple factors. These include the regular demand and supply factors and performances, corporate actions (for example in share and index CFDs) and other finer points that make markets move in the way they move. However, when you trade in treasury CFDs the major and some sometimes the only factor that you need to be aware of is the underlying profit (interest) associated with the treasury instrument related to the CFD. That means that your view of the market depends upon the direction in which you expect interest rates to move in future. 

Normally, treasury instruments and related CFDs trade at a premium if the prevailing interest rate in the country is less than the rate at which the bonds were issued at. That means that you would go long on treasury CFDs if in your view interest rates are likely to fall.

The other factor that influences treasury CFDs is the interest amount paid or payable on the bond. As time passes the face value of a bond increases in line with the interest accrued on it unless it is a bond that actually pays out monthly/quarterly/annual interest. In that case, the price of related CFDs will increase gradually in the run up to the record date for interest payment and revert back after the record date.   

Are Commodity CFDs a Better Option to Futures?

If you want to trade in commodities like oils, metals, grains and some agricultural or ‘soft’ commodities, a simpler way to trade them is through commodity CFDs. Access to commodity CFDs is much easier and more convenient than futures exchanges. However, just how many of these commodities are available to you depends largely on the CFD provider you choose.

It is crucial that you understand the way commodity prices are shown because it may lead to a bit of confusion at times. Commodity prices are reported as spot price (the current market price at which a commodity can be bought) as well as futures price, the price at which it will be available in future and reflects market sentiment. A regulated exchange shows the price of futures contracts and this is the underlying reference instrument of commodity CFDs. 

The price of commodity CFDs depends upon the futures of the underlying commodity. A CFD provider endeavours to match the bid and offer prices of commodity CFDs with prices in futures exchange but there is no guarantee.

Commodity CFDs enjoy a distinct advantage in that they provide easy access to commodity futures and lend well to trading flexibility due to smaller manageable lot sizes. However, all good things have a flip side. You may have to manage between futures and CFDs because the provider that you choose may not allow trading in all commodities that you want to. Moreover, it is not uncommon to see providers to increase their spreads to increase profits or manage their risks in volatile market conditions.

Bullion CFDs and Forex CFDs: The Connection

If you are an Australian and in any way connected with the financial markets you cannot afford to ignore gold. And if you are a forex trader, bullion CFDs provide you an excellent hedging opportunity.

Australia is one of the biggest producers and exporters of gold and its financial markets are greatly affected by the price of gold. For many years now, the currency pair AUD/USD has been moving in tandem with the price of gold, which is also the underlying reference asset for bullion (gold) CFDs.

CFDs refer to contract for difference that allows investors to take advantage of fluctuations in price without actually owning an asset. As such, when you create positions in bullion CFDs, you do not actually own physical gold or silver but only the right to make a profit or loss when the price gold or silver moves favourably. As an investor you must know certain basic aspects that relate to the positions you take in bullion CFDs.

Gold and silver bullion CFDs have a strong connection with Forex CFDs because the trading position you take reflects your view on the price of the metal in relation to currency value. While most CFDs are related to the underlying reference instrument or asset, gold CFD mean that you are taking a view on the price of gold as well as the currency it deals against. If you create a long position in gold you are expecting the price of gold to go up. It automatically means that you are short on the US dollar. Similarly, short positions in gold CFDs mean that you are going long on USD.  

All That You Wanted To Know About Share CFDs

Contracts for difference, commonly known as CFDs, are financial derivative products representing a trading contract between you and a CFD provider as the counterparty. A CFD has an underlying reference instrument and in the case of share CFDs, it is a share listed on an exchange.Trading in CFDs is similar to trading in shares and there is a huge potential for profits. As with any other high profit financial instrument, trading in CFDs is associated with an equally high potential for loss.

When you trade in share CFDs, you get a quote from the entity you are trading with. This quote will most often be the same as the price at which the underlying share is trading in an exchange. You are charged a commission on the full value of the contract that is number of CFDs traded multiplied by price. However, you do not pay the full contract value but only a percentage as margin money, which is meant to cover the risk exposure of the counterparty.

One of the biggest reasons why trading in CFDs is becoming increasingly popular in Australia is that it allows investors to trade long or short to take advantage from whichever direction you expect the price of the underlying reference instrument to move. You trade long in CFDs that you expect will show an upward movement and you go short if you expect the price to fall. 

At the same time, since CFDs are traded on margins and are leveraged products, trading in CFDs is considered to be riskier than normal share trading. Trading in CFDs without placing stop loss orders against each trade can result in a substantial loss.