When Did CFDs Emerge?
There are numerous ways to gain exposure to the share market. These include Cash Equities and Derivatives, including CFDs. Over the past decade, trading Contracts for Difference (CFDs) has become increasingly popular. Trading stock CFDs allows customers to gain exposure to the price movement of different stocks without the ownership of the underlying asset. CFDs are by definition contracts between two parties (i.e. the provider and you) to pay the difference between the entry and exit price. It is classified as a financial derivative instrument as its price is derived from the price of the underlying asset.
CFDs have opened the world of trading to the masses due to its ease of access and lower costs. This has both brought a wave of interest to the stock markets. Thus, giving trading and the stock market a greater focus.
When trading CFDs, it is crucial to use a reputable and regulated provider, such as Plus500. This ensures pricing and transactions transparency, as well as various client money protection measures. In addition, regulated providers should disclose the risks involved and are not allowed to trick traders with get-rich-quick schemes.
Trading Stocks vs. Trading Stocks CFDs
With CFDs, you trade with leverage. This means you can gain greater exposure to the underlying asset with less capital. Your total exposure compared to your margin is referred to as the leverage ratio. However, whereas your initial investment is lower, your total profits and losses are calculated at full position value. Therefore, leverage also implies greater risks and losses.
- CFD traders do not own the underlying asset over which the CFD is based, as opposed to buying shares. When holding shares, you generally have additional rights, such as voting rights and dividends.
- CFDs provide you with the opportunity to profit in both rising and falling markets - you can open a Buy position if you think the price will go up, and a Sell position if you expect the price to decrease.
- When you trade CFDs, you can easily access shares from several markets all over the world, as well as other instruments from the same account. This can make it easier to diversify your portfolio.
- With CFDs, you can place orders to either open or close positions at the rates you choose.
- When CFD positions are left open overnight, an overnight fee is charged. This makes CFD trading less suitable for long term positions.
- Opening a CFD trading account is usually faster than opening a traditional brokerage account.
- CFD trading is generally used for shorter-term trading during events such as earnings announcements. Share trading is most often used for building portfolios.
- Since CFDs reflect the underlying market, shares in the stock market and CFDs are traded much in the same way. The price a CFD provider would be willing to buy or sell a CFD at is derived from the price the stock is traded on the relevant exchange and in terms of notional value, one share is equivalent to one share CFD.
In short, trading CFDs on stocks and investing are two different things. Whereas the former is usually done in hopes of making gains in the short term, the latter is done by investors who hope to make gains in the longer run. Nonetheless, both trading CFDs and investing in stocks can provide opportunities. Therefore, whether you want to invest in stocks or trade stocks CFDs depends on your goal and financial vision.
Characteristics of Stock Trading and Stock CFDs:
||CFDs on stocks
|Owning the underlying asset
CFD Trading Example
Let’s take a look at a share CFD trading example with Plus500:
The price of one Apple share is $50 and you want to enter into a CFD contract of 15 shares. 15 shares x $50 per share equals $750. With leveraged trading, you do not need to invest the full $750. With a leverage of 1:5, your initial margin requirement for this particular share CFD is 20%. You will have to deposit $150 which is 20% of the notional exposure of $750. You need to make sure to have enough money in your account to open and maintain your position.
If you think Apple’s price will rise, you open a Buy position, and if you think it will fall, then you open a Sell position. You can choose to set stops to close your position automatically at a predetermined price. When you, or the stops added by you, close your position, the profit or loss will be added or subtracted from your account balance. If your position remains open after market close, you will be charged an overnight funding fee.
From the same account, you can also choose to trade shares listed in many different markets, such as Nintendo, BP or Adidas to mention only a few without any extra requirements.
The Bottom Line
CFD trading has both advantages and disadvantages when compared to regular share trading. Both ways of trading provide options to take advantage of price movements in financial markets. You need to understand your trading objectives and the kind of trading that best suits you and decide which way to go. If you’d like some more information about CFD trading, check out this video.