1. INTRODUCTION TO CONTRACT FOR DIFFERENCES
A beginner's guide
Any experienced investor looking to speculate on the stockmarket may consider borrowing money in order to buy shares that they feel sure are likely to go up. Typically, you might get a loan from the bank for say £20,000, and then buy £20,000 of shares in your chosen company or companies, in the hope of making a healthy profit that will more than cover the cost of servicing the loan.
Another way of achieving a similar goal is to buy a contract for difference (CFD).

2. WHAT ARE CFDS?
How do they work?
According to the technical definitions, a CFD is 'a contract designed to make a profit or avoid a loss through the movements in the price of an underlying item.' That item can be a stock market index eg, the FTSE 100, a bond, an option, but for the individual investor is most usually an equity, a share in a company that you do not physically own, but from which you get all of the associated benefits including dividends. Since you are not actually buying or selling the shares, CFDs are also exempt from stamp duty.

When you buy or sell (go long or short) a CFD, you are entering into a contract a broker, to exchange the difference between an opening value and the closing value of a particular financial instrument (share, bond, index etc.)

In most respects, buying a CFD mirrors buying the underlying instrument. In the case of an individual equity you will get dividend payments for example.

You will basically make a 'call' on whether you think a share, bond, or index is going to go up or down, and you will buy or sell a CFD accordingly. If you get it right, the company pays you the difference between where you bought, or sold, and the current value. If you get it wrong the CFD issuer is the winner.

Margin trading
Perhaps one of the major differences between trading CFDs and the underlying instrument is the fact that you can trade 'on margin.' In other words the broker will allow you to buy a certain value of CFDs by putting down a small percentage of the total value. For example, to buy £1,000 worth of shares you may only need to deposit £50 or 5% with the CFD provider.

You are effectively 'leveraging' or 'gearing' your investment, being offered credit with which to buy CFDs.

But it is this high level of gearing that makes CFDs particularly risky, and therefore unsuitable for any private investor who does not understand the risks or cannot afford to lose his or her investment. In effect, you can double or lose your money by just a 20% move in the underlying stock or index, depending if your call on whether they would go up or down was right or wrong.