Leverage

Investors can use CFDs as an efficient diversification tool because of the comparatively low execution costs and inbuilt leverage.  These factors allow capital to be used more effectively with the potential for higher return on equity. 

For example, stock XYZ is trading at the following prices:

Contract CFD Bid CFD Ask
XYZ Ltd 2.25 2.26

Using conventional share trading, investors would need $2,260 to buy 1,000 shares at $2.26. Using CFDs, investors can buy 1,000 shares with an initial margin of just $226 at $2.26 (assuming margin requirements of 10%). This effectively frees up the rest of the trading capital for use in other opportunities or is left in reserve to be put towards margin requirements should the position deteriorate.

Trading on leverage is a double-edged sword; The trader is controlling $2,260 worth of CFDs (stock equivalent) with only $226 inital margin indicating that the maximum risk if the stock went to zero would be $2,260, far more than the required initial margin deposit.  It is therefore important to employ effective risk management techniques and the right trading platform to assist in the management of trades.

Example of Long Index CFD Trade

A client is bullish on Straits Times Index SGD5 CFD and buys 1 contract.

Buying Price = 2,681

Scenario 1 

  CFD Bid CFD Ask CFD Closing Price
Day 1 2,675 2,681 2,693
Day 2 - - 2,707
Day 3 - - 2,740
Day 4 2,724 2,730 -

Positions are closed 4 days later at a higher value.

Selling Price = 2,724
Net Gain/Loss  = $187.47
Return on Equity = 27.97%

Calculations

Original Investment $670.25
Opening Contract of 1 Lot (Day 1) ($13,405.00)
Opening Commission (incl GST) ($10.70)
Financing Charges ($6.13)
Closing Contract Value (Day 4) $13,620.00
Closing Commission (incl GST) ($10.70)
Net Gain / Loss $187.47
Return on Equity = (Net Gain/Original Investment) 27.97%

Scenario 2

  CFD Bid CFD Ask CFD Closing Price
Day 1 2,675 2,681 2,693
Day 2 - - 2,655
Day 3 - - 2,642
Day 4 2,632 2,638 -

Positions are closed 4 days later at a lower value.

Selling Price = 2,632
Net Gain/Loss = (S$272.42)
Return on Equity = (40.64%)

Calculations

Original Investment $670.25
Opening Contract of 1 Lot (Day 1) ($13,405.00)
Opening Commission (incl GST) ($10.70)
Financing Charges ($6.02)
Closing Contract Value (Day 4) $13,160.00
Closing Commission (incl GST) ($10.70)
Net Gain / Loss ($272.42)
Return on Equity = (Net Gain/Original Investment) (40.64%)

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