Part 2 - Advantages and margin trading
Share CFD trading is very similar to normal share dealing in two respects. You deal at the cash price of the share, and pay a commission which is calculated as a percentage of the value of the transaction.
The big difference between normal share trading is that with CFD trading you do not have to pay for the full value of the position you have opened. Instead you put up a deposit, or margin. This will typically be from 5-10% for shares (and usually 1% for indices) which means you can trade up to 20 times your initial capital.
When you close your position, the difference between your opening contract value and your closing contract value is realised. So just as with buying shares or trading futures, the degree to which you are correct in your CFD trading affects how much you make or lose.
One key benefit of trading CFDs is that you do not incur any stamp duty, as you are not making a physical purchase. In fact, a brokerage using CFDs is usually much cheaper than buying shares through a full service broker.
The additional cost of holding a long CFD position over a traditional purchase is only the interest cost while a traditional share purchase incurs stamp duty at 0.5% (in the UK). Some CFD providers charge just £10 for trades of up to £5,000 while any trade of more than £5,000 may be charged 0.01% of the total trade amount.
With CFDs you don’t have to buy at the quoted price - you can sell too and profit from a falling market as well as a rising one. Other methods of shorting shares (such as borrowing stock) are often inconvenient and expensive which is why those who like to short-sell are increasingly choosing CFDs to trade.
A major advantage is that CFDs can be used to trade an extremely wide range of financial products and this means they offer an easy way to start dealing across a large cross-section of the market.
For example, if you have an interest in shares, the level of the FTSE 100 Index (UKX) or the Dow, the price of oil or the exchange rate of the dollar against the euro, you can deal all of these markets with one CFD provider on one account. This gives traders the ability to be more diversified in the investments across their portfolio.
They offer an alternative way in to the financial markets, and hold some significant advantages compared to traditional share dealing.
Say you want to trade out of hours. Many CFD providers offer extended hours meaning that you can trade some markets (like the FTSE or Dow) even after the underlying exchange has closed for the day.
Another reason traders like CFDs is that they are much less complex than options and warrants. Unlike options or warrants the CFD price directly mirrors the price and liquidity of the underlying market.
It is also easy to protect your position using stop-loss and contingent orders which can be placed easily. It means that you can place sophisticated orders like "if the market hits this price, then buy this many, but only after 2pm" which you would be hard-pushed to do with a traditional broker.
- Trading and Investing Strategies
- Edmond Jackson's investing master class
- How to trade CFDs
- How to trade forex
- Value investing for beginners