Why I Selected CFDs Instead Of Online Share Trading

It’s not tough to find blogs and forums where people talk about the advantages of CFDs over stocks however have you ever questioned whether the people really writing these reviews are investors that have knowledge in both financial products or are they simply salaried authors out to promote CFDs. In this short evaluation I am going to touch on the distinctions between both CFDs and equities and highlight the unique elements of both instruments which has allowed traders and investors to harness the power of their investment portfolio from the comfort of their very own lounge room.

CFDs and shares are especially different not just in the manner they work 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 not conducted on an exchange but instead with the CFD company that you’re trading with. Equities on the other hand are traded on an exchange meaning that you are buying and selling off others in the market with your share broker just acting like a intermediary providing you with a gateway to the market.

So now that you recognize 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 obvious variations between both products is the way they're settled. When you buy shares on the stock exchange you do not have to pay for the share for three days, conversely if you sell equities you don’t receive any cash for 3 days. The transaction day plus three days or T+3 is the settlement period set by the clearing house not the stockbroker. Of course when dealing in CFDs there is no clearing house involved because the trade is OTC, this means your CFD company effectively sets the rules, as CFD brokers usually do not like to wear the chance of having the settlement of a position fail they may request the money at the start, this idea of same day settlement is called T+1. It’s worth noting that a few online share brokers also apply T+1 settlement to reduce the chance of settlement failure.

There actually is no real advantage of T+1 or T+3 settlement as eventually the net effect is identical, though a large amount of active investors choose same day settlement for the simple reason that it makes their money flow less complicated to manage.

Gearing
Indisputably the most important and visible difference between CFDs and Stocks is the notion of gearing. By the very nature of the instrument CFDs are geared meaning that for a comparatively small expenditure you can obtain quite a substantial exposure to a share. Normally the gearing level on a large amount of CFDs is roughly ten percent this means that with a margin of $1,000 you can potentially gain $10,000 exposure to the price movement of a stock. If you were to buy $10,000 worth of stocks you would have to outlay the total quantity, as opposed to the $1,000 required to open your CFD position, providing a more efficient use of funds and return on your original investment.

It’s vital that you understand that though leverage can work in your favor, it might also work against you, which means your earnings and your losses are amplified however you may also potentially loose a lot more than your trading account balance. With stock trading on the other hand you cannot lose greater than the total amount paid, however you profit potential is also reduced.

Short Selling
Equally CFDs and stocks can easily be short sold although the process is often less complicated with CFDs for the simple reason that short sell dealings can easily be done on the internet instead of over the phone. The primary reason why short selling shares directly is not an easy process is attributable to short sale reporting necessities which have to be disclosed via tagging short trades executed on the exchange. Although CFD providers also have short sale disclosure requirements to meet they are not required to tag short trades for the simple reason that they often pre borrowed stock to cover any short sales, in effect this means that they've covered their clients short positions before the customer even places the order.

Trading Expenses
A common myth in the market is that CFDs are more affordable to buy and sell than stocks, however this isn't always the case. Financing plays an essential ingredient in CFD dealing however most traders regularly forget about this. Without conducting any numerical calculations as a rule of thumb an AUD $100,000 trade will cost you in the region of twenty five dollars each night in financing fees, on this basis as soon as you hold a position for a minimum of five days this is the comparable to paying out $125 in brokerage or 12.5 basis points. Needless to say if you don’t have the principal it may be worth paying this allthough if the gearing of the CFD is high it is best to think twice as CFD financing is not calculated on the borrowed quantity but rather using the full notional value of the trade as such it might be more economical to pay for your trade outright and pay a higher upfront commission charge.

CFDs can naturally be a cost effective dealing tool but this is only when trades are held open for quite a quick time period however, share positions on the other hand can easily be held open for as long as you prefer with only the first transaction fee payable, this is a crucial distinction to keep in mind.

Despite having to pay financing costs one of the benefits of CFDs is that you’re not required to pay any GST on your commission, although a comparatively small amount it is worth bearing in mind the impact of GST on your dealing costs if you are a frequent trader.

Unrealized Earnings
As CFDs are marked to market every day your gains or losses are also debited or credited out of your trading account daily this is extremely dissimilar to dealing in equities where profits or losses are only realized at the time of sale. In this regard one of the advanatages of CFDs is you are able to use your unrealized gains without needing to shut your positions, as you would expect there is also a draw back to this in that your losses are realized every day which means that unlike share trading the free equity within your account could decline without you closing trades.

Just five differences have been touched upon in this short article, in later content we'll cover some of the additional differences between stocks and CFDs. In the meantime if you would like to find out more exciting information about share and CFD trading you can get a hold of this complimentary CFD guide written by one of Australia's most well-liked CFD brokers, IC Markets.