Learn How Experts Profit From Online CFD Trading Instead Of Shares

It is not tough to find sites and stock forums where investors talk about the benefits of CFDs over equities but have you ever questioned whether or not the people actually writing these reviews are traders who have knowledge in both financial instruments or are they just paid authors out to advertise CFDs. In this brief assessment I will touch on the distinctions between both CFDs and shares and highlight the unique elements of each instruments which has allowed traders and investors to exploit the power of their investment portfolio from the comfort of their own lounge room.

CFDs and shares are vastly different not only in the fashion they operate but also in how they are traded. One of the important contrasts is the fact that CFDs are an over-the-counter or OTC instrument meaning your dealings are usually not performed on an exchange but instead with the CFD broker that you’re dealing with. Shares on the other hand are dealt on an exchange meaning that you are buying and selling off other people in the market with your equity broker merely acting like a conduit offering you with a gateway to the share market.

So now that you realize one of the primary essential differences between CFDs and stocks let’s get into some of the key mechanical differences in detail.

Settlement
One of the most apparent variations between both instruments is the way in which they're settled. When you buy stocks on the share exchange you do not need to pay for the equity for 3 days, conversely whenever you sell stocks you will not take delivery of any money for three days. The transaction day plus three days or T+3 is the settlement period set through the clearing house not the broker. Naturally whilst trading CFDs there is no clearing house involved because transaction is OTC, this means your CFD company essentially sets the rules, as CFD brokers usually do not wish to wear the chance of having the settlement of a transaction fail they will ask for the money at the start, this concept of same day settlement is known as T+1. It’s worth noting that some online stock brokers also apply T+1 settlement to reduce the chance of settlement failure.

There actually is no real benefit of T+1 or T+3 settlement as at the end of the day the net result is the same, however as a rule active investors favor same day settlement for the simple reason that it makes their cash flow less complicated to deal with.

Leverage
Unquestionably the most important and clear distinction between CFDs and Shares is the notion of leverage. By the very nature of the instrument CFDs are leveraged meaning that for a rather little outlay you are able to get quite a substantial exposure to a equity. Typically the margin rate on the majority of CFDs is more or less 10% which means with a margin of $1,000 you could potentially gain $10,000 exposure to the price movement of a equity. If you were to purchase $10,000 worth of stocks you would have to spend the full quantity, as opposed to the $1,000 required to open your CFD trade, providing a more efficient use of funds and return on your opening capital outlay.

It’s imperative that you understand that even though leverage can work in your favor, it may also work against you, this means that your profits and your losses are amplified however you can also possibly loose a lot more than your trading account balance. With share trading on the other hand you cannot lose greater than the amount paid, however you profit potential is also reduced.

Short Selling
Equally CFDs and shares can easily be short sold although the process is usually simpler with CFDs for the simple reason that short sell transactions can be completed online instead of over the phone. The primary reason why short selling equities directly is not a simple process is as a result of short sale reporting necessities which need to be disclosed via tagging short trades executed on the exchange. Although CFD providers also have short sale disclosure requirements to satisfy they are not required to tag short deals for the simple reason that they often pre borrowed stock to cover any short sales, essentially this means that they've covered their clients short positions before the trader even places the order.

Costs
A common fable in the market is that CFDs are less costly to buy and sell than stocks, however this isn't always the case. Financing plays an essential ingredient in CFD trading however a large amount of investors time and again forget about this. Without conducting any mathematical calculations as a rule an AUD one hundred thousand dollar trade will cost you in the region of $25 per night in financing charges, on this basis should you keep open a position for around five days this is the equivalent of paying $125 in brokerage or 12.5 basis points. It goes without saying if you do not have the money it may be worth having to pay this allthough if the margin of the CFD is high you might want to think twice as CFD financing isn't calculated on the borrowed amount but rather using the full theoretical value of the trade as such it may be more economical to pay for your trade outright and pay a higher upfront brokerage charge.

CFDs can certainly be a cost effective dealing tool but this is only when trades are held open for a relatively brief time frame on the other hand, share trades on the other hand are generally held open for as long as you want with only the initial transaction fee payable, this is a crucial distinction to keep in mind.

In spite of having to pay financing costs one of the benefits of CFDs is that you’re not required to pay any GST on your trading charges, although a rather small amount it is worth bearing in mind the impact of GST on your trading costs if you’re an active trader.

Unrealized Profits
As CFDs are marked to market on a daily basis your profits or losses are debited or credited from your trading account each day this is rather different to trading shares where earnings or losses are only realized at the time of sale. In this regard one of the benefits of CFDs is that you can utilize your unrealized gains without needing to shut your positions, of course there is also a draw back to this in that your losses are realized daily which means that unlike stock buying and selling the free equity in your trading account might decline without you closing trades.

Only 5 dissimilarities have been touched upon in this article, in later posts we will cover some of the other dissimilarities between equities and CFDs. In the meantime if you want to find out more interesting information about equity and CFD trading you are able to download this complimentary CFD guide published by one of Australia's most well-liked CFD brokers, IC Markets.