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CFD's - How it works - an example
One Monday the shares of ABC plc stand at 100p each. Two would-be investors are looking at the company but both have different opinions on how the shares will move.
John believes ABC is an industrial champion whose shares can only go higher and he buys a long CFD against 10,000 shares in the company. The CFD broker asks for 20% of the value of the contract so John pays him £2,000. The contract is worth £10,000 and will rise in value if the shares go up.
Jim believes ABC is in trouble so he buys a short CFD on 10,000 shares. Jim pays out his initial 20% (£2,000). His contract is also worth £10,000, but it will only rise in value if the shares fall.
On Wednesday ABC issues a disastrous statement advising its finance director has disappeared and the company has a huge hole in its finances. Consequently, shares in ABC plc plunge from 100p to 50p each.
John is in serious trouble. The difference between the two prices in his contract is £5,000 in favour of the CFD broker. Not only has he lost his initial stake of £2,000, but he now owes the broker an extra £3,000. John must decide whether to close his CFD's now and pay up or whether to hold on and hope the shares back go up. But if they fall again he will owe even more.
Jim is very happy. The difference in price is 50p a share or a total of £5,000. That, minus commission and interest charges, is straight profit to him.
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