Contracts for Difference (CFDs) are contracts between a trader and a CFD provider, who will at the close of the contract, exchange the difference between the opening price and the closing price of the underlying index, share, commodity, per the number of specified CFD contracts.
A CFD differs from the traditional trading methods as it is not a purchase of the nominated investment, but trading on its speculated price movement. The main idea of CFDs is the ability to be able to trade higher volumes than traditional trading while using less initial capital.
The buyer of the contracts is required to pay commission to enter the contract, plus fixed interest on the remaining value of the borrowed amount, until they decide to end the contract, at which time they are paid the price difference. The buyer may opt on either side - high (buy) or the low (sell), which means that if the contract was a low trade the buyer could still turn a profit it that was the initial investment.
Advantages of CFDs versus traditional share buying
The key distinction between traditional share buying and CFD buying is that buying a CFD is done on leverage (typically between 5% to 35% for actively traded stocks), both shares and CFDs participate in all corporate actions, both buyers receive dividends but only the buyer of the share is able to vote and receive the franking credits. To select a great broker if you are trading in Asia, Australia, or UK vist www.cfdfxreport.com and look at choosing a broker or simply email support@cfdfxreport.com as we have researched them all.
With CFDs one is not entitled to these rights, which enables CFD sellers to sell with ease. This makes CFDs an excellent trading product. The leverage and ability to short sell gives power and flexibility.
Unlike futures, CFDs do not have an expiry date, so one can hold on to them for as long as they desire. CFDs open up a whole new trading world, with the ability to trade shares, indices, foreign exchange, and commodities.
CFDs are the flexible new way to trade. One can trade Singapore Stock Exchange (SGX) listed shares but you have access to worldwide markets, such as the United States (DOW, NASDAQ, S&P), United Kingdom (FTSE), Japan (NEIKKI), Hong Kong (Hang Seng) and many other countries.
1) Leverage
If you do not have the money needed to trade shares directly on the Singapore Stock Exchange (SGX) trading CFDs can offer you the exposure required to make a profit from small percentage moves on the underlying share price. The leverage level offered by the CFD provider magnifies the underlying movement of the stock. Most providers set differing leverage levels and you can find the best level that suits you trading style. Certain CFD providers offer, at a cost, a Guaranteed Stop Loss (GSL) that can effectively increase leverage levels further by capping the margin requirement held against you.
2) Controlled Risk
If you have ever traded, you know how important it is to use stop losses for capital preservation, especially when using a leveraged product.
CFDs allow you to cut your losses quickly and leave your profits to run. This ability to quickly exit at the prevailing market price allows for greater risk control.
CFDs reflect the price of the underlying equity. Therefore, you will always know what the market price is of your shares and know what you can sell out for, provided you choose a CFD Provider who uses "at market" prices. Some CFD providers (market makers) may only give spreads, which have the potential to force you in at higher prices and out and lower prices.
Placing automated Stop Loss orders can exit you out of suggestions that go against you while you are busy in your day-to-day activities. Example:
XYZ Ltd is currently trading at $9.95 bid and a $10.00 ask price. You want to buy 1000 shares of XYZ Ltd share CFDs at the offer price of $10.00, with your view that the stock will rise in price.
We are working on the leverage margin of 1:10. Therefore every dollar of capital you invest the CFD provider will provide you with $10 of leverage.
CFD Trading Traditional Shares
Buy Price $10.00 Buy Price $10.00
Initial Margin (10%) $1,000 Initial Outlay $10,000
Brokerage $17 Brokerage $30
GST 5% $0 GST $1.50
Total Outlay $1,017 Total Outlay $10,031.50
Traditional brokers require that you have 100% of capital required for the trade upfront.
The difference in funds required between the CFD provider and the traditional way of trading is $9,014.50.
Closing the trade
CFD Trading Traditional Shares
Sell Price $10.25 Sell Price $10.25
Gross Profit $250 Gross Profit $250
Brokerage $34 Brokerage $60
GST 5% $0 GST $3
Finance Charge $1.45 Finance Charge $0
Net profit/loss $218.55 Net profit/loss $187
In this example the trade was positive for the trader.
If the stock had of fallen by $0.25, you would have realized a gross loss of $250 with both the CFD provider and the traditional broker.
The net loss would have been $285.45 with the CFD provider and $313 with the traditional broker.