IF THE fact that investments can fluctuate does not faze you, then Contracts for Difference, or CFDs, may be
an attractive trading option.

CFD is a contract between a buyer and a seller, in which the seller will pay to the buyer the difference between the current value of an asset and its value at contract time. If the difference is negative, the buyer pays the
seller instead.

CFD trading predicts the price movements of assets. Traders can buy (go long) or short-sell (short) an underlying
stock or share without having to physically own them.

Like shares, CFD profit or loss is determined by the difference between the buying and selling prices. Under a CFD contract, cash is paid out to cover the difference.

However, unlike shares, CFD trading has two special features: short selling without having to borrow shares and leverage or investments with borrowed funds. Both are attractive because investors can profit when markets rise or fall.

As an over-the-counter instrument, CFDs let investors short-sell without worrying about buying-in or having to
borrow shares to trade, which can be expensive and inconvenient.

Leverage is another potential perk. CFDs enable trading up to five times the initial investment amount.

Mr Edmund Liew, a dealer in Phillip Securities, explained: 'An investor with $1,000 would be able to trade up to $5,000. Customers have to understand this part before they start their first CFD trade.'

That means a sum of $1,000 in capital can be used to make investments of up to $5,000, with potential profits based on the latter amount.

Conversely, if investments go against prediction, potential losses are also higher. This is because a relatively small price movement in the underlying instrument can magnify the profit or loss performance, which explains why the risk for CFD trading is higher, said Mr Liew.

Nonetheless, CFDs are likely to appeal to adventurous investors who are comfortable trading in and out of volatile markets.

Upfront costs include an initial capital of $3,000, an opening commission charge (either $22 or 0.2 to 0.5 per cent of the contract value, depending on the stocks or shares chosen), a maintenance margin, interest and a closing margin, which is the same as the opening commission.

The maintenance margin is an amount equivalent to 20 per cent of the full contract value. This has to be kept in the account at all times to maintain the CFD contract.

For those who 'go long', interest is calculated daily at 5.5 per cent per annum. Investors who 'short' pay either 4 or 8 per cent per annum, based on the type of stocks.

Like any financial instrument, CFD trading also has its pros and cons.

CIMB-GK economist Mr Song Seng Wun offers this advice: 'Ultimately, it's all about product knowledge and whether you are comfortable with the way this derivative works.'

This article was first published in my paper on May 20, 2008

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