Contracts for difference allow for a flexible way to trade most of the world’s global indices on margin by utilising Index CFDs. Index CFDs empower speculators to gain exposure to a large number of different stocks in just one transaction. Effectively, you are trading on a basket of stocks for the country you choose.
You will find that the broker offers CFDs on diverse indices from all around the world, which means you can take part in the world markets. Using Index CFDs you can get exposure to the ups and downs of any particular country’s economy and they are popular with individual traders because of this quality: the ability to take a position on a whole market without having to check the prospects for any particular company’s shares. The margin rate is low, around 3%, and there is no commission as the broker profits from the spread. It is a good way to gain exposure to a foreign country’s markets.
Trading Indices
Depending on what you want to do, you may be more interested in indices than you are in the individual companies. Certainly, when it comes to CFDs, you may deal directly with the indices more than you do with individual stocks. When you are starting out, there are only a few main ones that you should pay attention to. The indices are made up of the main stocks traded on the particular market.
The Dow Jones Industrial Average is the most well known one in the USA. It only comprises 13 companies, somewhat surprisingly, and the share prices all have different factors to keep a good spread of the various industries. From time to time, but rarely, the list of companies is revised, and 30 different companies have been used since 1928. This index does not include transportation, as that is in a separate index, and the relationship between the two indices is part of the Dow Theory.
In contrast to this, in the UK the indices are commonly in two sizes, the FTSE100 and the FTSE250, having the top 100 and 250 company stocks, respectively. Using 100 stocks is much more than the Dow Jones, though it doesn’t include many of the available stocks on the London Stock Exchange. Even so, it covers 70% of the capitalization of the LSE, and thus is very representative of the UK’s financial climate.
A third main index is the NIKKEI, which covers the largest companies in Japan. It’s based on 225 prices on the Tokyo Stock Exchange. If your trading plan includes trading on indices, it’s quite likely to include one of the above, although there are many more in existence – the Wall Street Journal, publisher of the Dow Jones indices, tracks 130,000 of them!
Index Based CFD Trade Example
In the final example, we introduce margin requirements, using an index based CFD trade. Suppose the FTSE 100 stock index is at 7501.5 and we think it will decrease. A short position on the index is taken and the brokers bid/offer price is 7500.5/7502.5. To open a position we sell 5 FTSE 100 CFDs at bid price, (5 x £<7500.5 = £37,502.5). The margin requirement which is the open position times margin percentage, for the example, suppose the margin requirement is 1%, then the margin requirement is £37,502.5 x 0.01 = £375.03. The next day suppose the FTSE 100 dropped by 50 points to 7450.5 bid and 7452.5 offer. To take profit, you would close the position. This means buying back the position at the lower price at 5 x 7452.5, so the profit is the difference between opening position and closing the position (£37,502.5 – £37,262.5 = £240.00). If this was a long position on the FTSE 100 index, overnight charges would be deducted from the total balance. Overnight financing is made each night, based on a benchmark rate such as the LIBOR rate + the broker's margin percentage divided by 365.
