Understanding CFD finance is much easier when you understand the whole process of trading a CFD. A small margin requirement is all that is required to buy a CFD which covers any loss you make on the position. As the underlying instrument moves the margin amount will also vary. The margin payment that you make does not cover the cost of the underlying position.
The CFD Broker then protects the position they hold by purchasing the underlying instrument and the cost of this is the full value of the position. The CFD broker is effectively lending you the money to buy the underlying instrument.
Buying CFDs And CFD Finance
When you buy a CFD the CFD Provider 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.
As an example if you bought 1000 MSFT using CFDs at $ 23.00 then interest would be charged on $ 23,000. Trading long the interest is charged on the full position. This is CFD finance in action.
Short Selling And CFD Finance
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 CFD Providers bank account if they sell the underlying stock.
If you were to sell 1000 BA CFDs at $ 43 then you have sold a position of $ 43,000 on which you would receive interest. This is CFD finance on the short side of the market.
Costs Of CFD Finance
The calculation of interest rates is almost the same for different CFD brokers. Short positions receive interest at a base rate less a margin of 2 – 3% while long positions pay interest at the same base rate plus a margin of 2 – 3%. The base rates used are usually the Reserve Bank of Australia Cash Rate (RBA) or the LIBOR (London Interbank Offered Rate)
The interest rate difference from the margin that the CFD broker charges is one of the ways the CFD broker makes money. CFDs could be considered to be a complicated way of lending money for the CFD broker.
When Is CFD Finance Charged
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.
The rate of interest is very low relative to the impact of movement in a CFD position. With current interest rates at about 6% per annum fluctuations in the CFD position can easily be more than this in a day.
