One of the advantages of trading CFDs is that you can have one CFD dealer but have access to almost unlimited types of markets. CFDs can be traded for virtually every type of market in the world, so you can choose which ones are acting favorably for trading, for example looking to markets that are strengthening or that have definite price trends at the moment.
Each share that is traded on the stock market is allocated to a particular industry sector, depending on the type of business the company transacts. Sector CFDs allow you to take an overall view of the economy, and choose a growth area such as health care for your trading. If you trade in sectors, you need not get involved in analyzing individual companies and stocks, but need only to see the big picture to determine which areas to follow. There are many different sectors that you can choose from, including financial sectors, energy, transportation and others, so that you are bound to find a sector that is experiencing a bullish (or bearish) trend that you can trade. You can also use the sector trades to go long or short of areas like miners, food producers or real estate if you think that they are under or overvalued or will outperform or underperform the market as a whole.
Another advantage of using sector CFDs is that your investment is automatically diversified across a range of companies, as the CFD includes many stocks from that sector of industry which reduces stock specific risk. This means sector CFDs are usually less volatile than trading individual shares. An example of this would be holding a long position in the UK oil and gas sector compared to a pure long in BP. It is much easier to identify trends in a sector as a whole, rather than examining the charts of several different companies. While most shares tend to follow the general trend of a sector, there’s always the possibility that a few will not. Trading the whole sector reduces your exposure to this risk. Advanced strategies like pairing are also possible with sectors. For instance, if you believe an index will rise but one constituent sector will retrace, you can maximise your potential profit and go long on the index but short the sector.
There are three points to watch with sector CFDs. Firstly, as with all CFDs, you are trading on margin. While this means that a small investment can control and profit from a large quantity of shares, it also means your account is charged interest while you hold a long position in the CFD. Secondly, margin trading means that if you have made a bad choice you can lose all of your investment, or even more. The same mechanism that multiplies your gains on a winning trade will also multiply your losses.
The third less obvious disadvantage is that sector CFDs tend to have a wider spread than equity CFDs. Spread is the difference between what you can buy them at and how much you can sell them for, and is where the broker makes his profit. If you are considering a sector which is dominated by one or two companies, you may find it more economic to buy equity CFDs in those companies.
Note that only market makers are able to offer sector CFDs and not all providers cover them. Two that do are IG Markets and CMC Markets. CMC cover 19 UK sectors and a number of sectors based on the USA economy all at very competitive margins. IG Markets even quotes a number of Australian sectors. The USA sectors are particularly attractive for traders who are looking to trade trends for longer periods as they provide diversified exposure across an industry. You’ll find that different sector CFDs will vary in the specification of price per point in the underlying. Sometimes it is $1/£1 per point and sometimes $10/£10 per point. You may also find that individual dealers have slightly different sector values than given by your charting software. Say you had a healthcare sector CFD valued at $5500 at $1 per point. You would be in control of $5500 worth of sector shares for a margin value of, say, 1%, or $55.
Consider your position if this rose in value to a sell price of $5590 within a week. You would sell the contracts to make a gross $90. You would be charged interest for each day that you held the position, and this would reduce your net profit to about $80. Overall, you would have made 145% on your money in one week, demonstrating the power of leveraging your trading.
CFD Sectors Coverage
The following sectors may be available (depending on your provider):
- Aerospace & Defence
- Construction & Building Materials
- Electronic & Electrical Equipment
- Engineering & Machinery
- Food & Drug Retailers
- Food Producers & Processors
- Household Goods & Textiles
- IT Hardware
- Leisure, Entertainment & Hotels
- Life Assurance
- Media & Photography
- Oil & Gas
- Oil Equipment
- Pharmaceuticals & Biotech
- Real Estate
- Software & Computer Services
- Speciality & Other Finance
- Support Services
Some providers may quote standard and mini contracts on the following sectors:
- Consumer Discretionary
- Consumer Staples
UK and USA Sectors
The spreads on the UK and USA sectors are very much on similar terms. For instance, at the time of writing CMC were quoting the UK Banks sector CFD at 4486 – 4495 and the USA Banks sector CFD at 384 – 389. No extra commissions are applicable apart from the dealing spread (this normally amounts to 0.4% for all contracts on all sectors although this is subject to variation especially in volatile conditions) and a financing fee that is charged for long positions held overnight. Providers compute their prices by taking the spot price and adding a small percentage to the bid and offer prices.
Taking a look at the UK banking sector, this is made up of Barclays (BARC), HSBC (HSBA), Lloyds (LLOY), Royal Bank of Scotland (RBS), Standard Chartered (STAN), TSB (TSB) and Bank of Georgia (BGEO). Let’s suppose you thought that the UK banking sector is looking healthy but you weren’t certain which banks to buy so you buy the banking sector index using a CFD and try to trade it this way. Suppose you look at the September contract and this is quoting at 4600/4631. Your trade will be executed at 4631 if you wish to go long and 4600 if you wish to open a short position.
Points to note:
- Not all CFD brokers offer sector indices.
- The minimum transaction size for a sector CFD is one contract.
- The margin factor varies from one sector to the other. For example the margin factor for banks is 12.5% of notional value.
- Some providers consider one CFD as equivalent to £/$/€ 1 per point while for others one CFD is equivalent to £/$/€ 10 per point.
- No commission is charged apart from the dealing spread (typically 0.4%) and a small financing fee for positions held overnight.
- Sector trades are a good way to have a diversified view on a specific industry as it takes away the risk of putting all your risk in one share and diversification is sound as far as risk management goes.
- Sector dealing cannot result in the delivery of any stock or instrument by or to the trader.
- The constituents making up a sector CFD are usually very liquid shares. For instance the sectors that a provider quotes could be based on shares that make up the FTSE 350 and ASX 200.
- Note that not all sectors are equally balanced. For instance the banking sector is made up of seven companies which provides some diversification across the sector but other sectors consist of only one or two companies, sometimes with just one company having a disproportionate weighting in the sector. As such just one underperformer in certain sectors can impact the entire sector and in such cases it makes more sense to take individual positions in the companies. Looking at the oil sector for instance, the sector’s performance is mainly dependent on the major companies like BG (BG.), BP and Royal Dutch Shell.
- As with all CFD contracts you can use limit and stop orders on sector CFDs. IG Markets even provides Guaranteed Stops and Trailing Stops to cap your risk without limiting any potential profit.
- UK sectors can usually be dealt from 08.15 to 16.30 (UK time). Australian sectors can be dealt from 10.10 to 16.00 (Sydney time).
- You can use CFD sectors to take advantage of particular market trends or trade the performance of one sector against another like going long utilities and short real estate.
CFD Sectors: Trading Examples
City Index: Mining Sector Index
Let’s take an example: suppose City Index is quoting the mining sector CFD at 17325 – 17385. With City Index each contract comes at an exposure of £1 per index point and the margin requirement is 5%. You want to buy 5 contracts which gives you an exposure of £86,925. To open this position you would need to deposit margin funds of £4347 (5% of £86925). If over the next 3 days the mining sector index has risen to 17450 – 17510, the sector CFD could be closed for a gain of £325 less financing costs of around £20.
Retail Sector Index
You believe that after upbeat sales figures released over the Christmas period by a number of department stores, that the Retailers sector is ripe for a re-rating and is likely to rise.
You check the retailers sector index which is being quoted at 1796/1804 and you decide to buy one single contract (with one contract being equivalent to £10 per index point) at 1804. The initial margin required to open this position is 5% so you need to have £902 (1804 x £10 per point x 5%) in your account to open this position. Over the next few weeks however, the market moves against you and the retailers index falls to 1716/1724 and you decide to exit by selling your contract at 1716.
Your loss on the trade is calculated as follows:
Closing level: 1716
Opening level: 1804
Loss: 88 points x 1 contract x £10 per point = £880.
Note that to compute the overall result you also have to factor interest and dividend adjustments which are calculated on a daily basis in exactly the same way as equity CFDs.