Why CFD shares trading differs from traditional stocks
The beauty of contracts for difference is that they can be used with just about any underlying asset, and they frequently are. CFD shares trading has become very popular, perhaps because people who understand shares feel a little more comfortable when transitioning to this popular derivative.
Make no mistake though, CFD shares trading is a different beast from traditional stocks. For a start, you don’t actually own the shares. You use leveraged money (so investing is cheaper) to speculate on price movements of whichever share your contract is based on. If you haven’t heard of leveraging before—and many people haven’t—it’s effectively borrowing to invest. You can open a contract for difference that may only cost you around 1/10th of the share’s face value.
This means that you get access to all the benefits of speculating on major company share prices without paying as much upfront, and without owing the government any taxes on the shares that you own—because of course, you don’t own them! This does vary between jurisdictions so it’s best to check the tax rules and your location.) Your actual provider sets the CFD price when you are CFD Shares Trading, but it’s usually set at the price of the actual shares themselves. If you’ve traded stocks before then CFD shares trading won’t feel so much different, but there are some key differences and it’s important that you understand them.
As we’ve said, you’re not buying or selling any actual shares, so you never own them. What you’re doing is placing a bet on whether you expect the price of the shares you are interested in to go up or down, and you can track what’s happening with your account through the online dashboard that most of them offer. The cost of commission for CFD shares trading is less than the cost of commission that comes with trading shares. This is one reason why CFD trading is so popular. The bar to entry is so much lower than with normal shares. Another reason why CFD shares trading is popular is that CFDs are traded on margin. Margin is the minimum deposit that’s needed in your trading account so you can trade.
CFDs also offer leverage, so-called because you are using your small deposit like a lever to trade with a bigger amount. But, something to keep in mind when using leverage in CFD shares trading is that even though your potential profits are bigger, your potential losses can also be bigger too. They can actually be bigger than what’s in your account. Sometimes you need to keep position open overnight, and this is where overnight financing charges come in. The broker sets them, usually basing them on a standard interest rate benchmark, such as LIBOR. The amounts are usually quite small, but they do add to the cost of doing business, so they are something that you need to keep in mind when considering trades and calculating your profits.
Another aspect of CFD shares trading that attracts investors is the fact that it’s equally easy to take long or short positions. The beauty of a short position is that can make money even when share prices are falling. It is possible to take a short position with shares bought in the traditional way but doing it this way round usually means that your broker needs to borrow shares from someone else. It’s a complicated way of doing business and CFD shares trading is much simpler in comparison. There is a downside to CFD shares trading, just as there is with everything, and to be aware of what can go wrong. As we mentioned, CFDs involve leverage, which means that you can easily lose more money than you actually have in your account if you take the wrong position on a trade.
It takes discipline to let go of a losing position before its losses overwhelm you, and it takes analytical skills that you’ll need to master in order to identify the shares that have the greatest chance of moving in a direction that means profit for you. It’s a raging certainty that even with detailed analysis things won’t go your way all the time, but your odds of success are improved if you cultivate discipline, learn the right skills and apply them rigorously. It’s worth mentioning here that for any long CFD that you hold overnight the cost of borrowing isn’t reduced by leverage. It’s the same as the cost of borrowing the total value of the shares.
Some brokers charge a commission on every transaction, but oftentimes the CFD provider’s profit comes only from the difference between the price they quote you for buying and for selling the CFD, which is known as the spread.
So, now that you understand some of the ins and outs of CFD shares trading, here’s an example of one in action:
Let’s assume that Dyson shares are trading at 323.9/324 cents (bid/offer) and we know that share CFD prices track the market prices of the underlying asset. The CFD price for Dyson is therefore 323.9/324 (sell price/buy price). If you think that the share prices will rise very soon you might buy 10,000, CFDs of Dyson at the buy price of 324 cents.
If you’re right and the Dyson shares do go up, then can close the trade and cash in your profit, which, if it’s gone up to 343.9/344 will give you $1,990 in profit (before commission). How do we work this out? A CFD is a contract between two parties, who agree to exchange the difference between the opening and closing prices. In our example the market shifted up by 20p per share, just as you thought it would. So, your 10,000 units at 343.9 cents became worth $34,390. The opening value was $32,400, or 10,000 units at 324 ). So, you pocket the difference. Of course, if it had gone the other way then the other party would have been the one making money.
It should be clear by now that there is more to trading on the stock markets than just buying shares at one price and hoping to sell them later at a higher price. CFD shares trading gives you an opportunity to make money even in the middle of a bear market, when all shares are sliding, and you can do so for less than the normal price of entry.