A contract for difference (CFD) allows you to speculate on whether the price of an index will rise or fall. Index CFDs are traded specifically on indices, such as FTSE 100, CAC 40 and Dax 30. Index CFDs are different from single stocks because they allow speculators to take a position on the future movement of an entire market rather than just one company’s value 

What is an Index CFD?

An Index CFD is a contract between a trader and an online trading company that allows the trader to profit from rises or falls in a market index. There are many different indexes, but the most common ones used for this trading method are FTSE100, S& P 500 and other stock indices such as Basic Resources BCOM. 

The main steps involved in trading Index CFDs are:

1. You open your trade by paying your margin deposit at your broker’s website or through their mobile app. Your contract will be marked as open, and your broker takes the margin with no movement in the index price.

2. You can either close out your trade or leave it open, meaning you will make a profit if the index goes up or lose money if it goes down. Suppose you choose to stay long (so still think that prices will go up), then at expiry. In that case, whether that be the end of the day or on a particular date (known as ‘expiry’), you’ll need to pay an additional amount known as ‘variation margin’. Again, this is paid via your online account and ensures that your broker doesn’t have to take any further action on your behalf. The variation margin is based upon where the index’s current price sits in relation to the price at the beginning of your trade. If this is positive, then you’ll pay a variation margin. If negative, then you’ll receive it.

3. At expiry, your CFD will either be ”in the money” or “out of the money”. If in the money, meaning that prices have gone up since opening your trade, then you make a profit equal to the difference between where prices are now and where they were when you first traded – known as closing at spot. If out of the money, meaning that the index has fallen since opening your trade, there’s no need for any further action on your part, but if it goes back up before expiry (called snapping back), then you may find yourself having to pay more variation margin.

4. If expiry passes with the index price at the same level as when you first traded, this is known as ‘at the money’. You’ll receive no further variation margin payments or profit/loss at this point, but your trade will remain open. Even if your CFD tracks a fall in future, it won’t be closed out unless you take action to do so. Your only option is to wait until the market closes and hope for a rise in prices before opening another trade on an index investment.

What are the benefits of Index CFD trading?

Index CFD trading can be very beneficial because you can make investment decisions without worrying about cashing them in. You should never forget that gains and losses are magnified when using Investment CFD’s because of leverage. 

With other forms of CFD Trading, you’re only required to put down a small percentage of the total trade. However, with Index CFDs, it’s a different story. For example, if you wanted to invest in Facebook shares through an Index CFD broker, chances are the amount they quote will be multiplied by 100 or more. This means that even though your actual shareholding will not rise or fall by 100 times your initial investment, there’s a high chance that your investment (and thus the gains or losses on it) will be.

Final Word

As with all types of CFD trading, Index CFDs can bring huge rewards if you trade sensibly and manage your risk effectively. It is recommended that you use reputable online brokers such as Saxo Bank and try a demo account before investing your own money. For more information, check this here.