The presence of CFDs, (Contract for Differences) on the London Stock Exchange has increased significantly over the past few years. These days, estimates put the daily volume represented by CFD trades to be somewhere close to 40% of the London Stock Exchange’s daily volume. This contrasts starkly to a figure of less than 7% representation back in 2000.
CFDs have enjoyed enormous growth in popularity over the past few years and the reasons are fairly easy to understand; low deposits, no stamp duty and the ability to make a profit from a falling share price.
The critical difference between trading a CFD and a normal share is that instead of paying the full value of a share and becoming the owner, instead the individual only pays a 10% deposit of the share's value and at no stage takes complete ownership. CFDs are derivatives and the leverage they afford can multiply profits yet on the other hand can magnify losses greatly.
In principle they are not much different to an option or future however, there is no expiry so in theory you can keep them open for as long as they are in the money (in practice they are used to exploit short term strength or weakness in a share, alternatively they can be used to hedge a share portfolio.)
Essentially a CFD is an agreement to exchange the difference between the opening and closing price of a stated transaction multiplied by the number of shares specified in the contract.
The benefits from any profits, dividends or uplift achieved on the contract are due on the full amount controlled however, so is the full liability for any loss. In other words the risk posed to your investment is much greater but by default so is the chance of generating a much larger profit margin than with is possible with traditional shares.
As a result, trading CFDs successfully is a fine art and inexperience can lead to losses far greater than the deposits used to open trades. For this reason the use of CFDs within SIPP’s needs to be considered very carefully.
It is essential that basic risk strategies are used when trading CFDs in order to prevent any adverse market movements forcing your CFD account into a margin call (a margin call is a requirement for extra funds to be put your account to keep your positions open).
The main controls which should be considered include the following:
- A limit set on each contract to a level not exceeding the amount deposited into the CFD account.
- A limit on the account itself so that no more than 70% of the funds deposited are committed to open CFD positions.
- Each CFD should have an automatic stop-loss set on it.
- Each CFD should have a target price set on it.
The discipline of having automatic stop-losses and targets set on each trade ensures that any emotion is removed from trading, limiting the potential for things to go seriously wrong.
In brief, CFDs were originally designed for use by professional traders and fund managers, so when considering their inclusion within your SIPP you must consider the fact that you will either need to work alongside an advisor who can monitor your CFD positions on your behalf or be prepared to dedicate your own time to monitoring the market from 8am through to 4.30pm when the UK stock market closes.
If disciplined strategies and controls are implemented then the use of CFDs within SIPPs can be extremely profitable but as always the old adage BUYER BEWARE should be remembered before you consider including CFDs within your SIPP.