In the early days traders needing to borrow money to trade had few options, either borrow funds from the bank to buy stocks or call your stockbroker and apply for a margin loan.
In 2003 traders and investors in Australia got an additional option, CFDs. Since their introduction the industry has changed, CFDs being a simple form of margin lending have become the fastest growing derivative product in the country, outstripping the growth seen in the warrants market during the mid 1990’s.
No longer does a retail investor need to apply for a bank loan or deal with expensive full service stockbrokers. CFDs have revolutionized the financial services industry, retail investors can now open a Contract for difference account over the internet in minutes and be up and trading before the conclusion of the day, executing all of their orders in real-time on the internet.
Unlike margin lending CFDs are usually traded over the web with the trader’s portfolio being marked to market in real-time throughout the trading day, this is substantially different to the end of day portfolio revaluations utilized by margin lenders. Real time portfolio margining means that traders can properly accurately manage risk right through the trading day rather then having to wait for statements to be generated at the end of the trading day.
Similar to shares acquired using a margin loan CFDs also offer the holder the ability to collect a dividend, however in most cases franking credits aren’t passed on to the holder of a CFD unlike that of a margin loan. The reason franking credits are not passed on when holding a Contract for difference is because the purchaser of a CFD holds an over-the-counter derivative contract and not the real share. Not possessing the physical stock whilst owning a CFD position also means that the owner of the CFD isn’t entitled to voting rights in the listed company over which the CFD is quoted. Many Contract for difference traders only hold their positions open for a small time period and aren’t interested in voting rights or franking credits but instead have an interest in making a profit from the short term price changes of the CFD.
Among the most significant advantages of Contracts for difference is that traders are able to sell them as easily as they are able to buy them, this means is that going long is just as easy as going short permitting traders to profit in falling markets. With conventional margin lending short selling is difficult and near impossible.
Contracts for difference are reasonably inexpensive in comparison to margin lending, typical brokers offering margin lending will charge 0.50 percent whereas a typical CFD provider will charge 0.10 percent. One thing to be wary of are the interest rates charged by margin lenders and Contract for difference providers. It is vital to note that margin lenders will charge interest only over the sum borrowed whereas CFD companies will charge interest on the full notional value of the position, however, Contract for difference financing charges tend to be lower. Financing rates are vital to think about when evaluating both products, however, this is often less significant for CFD traders that only hold their positions for a brief period of time.
Generally Contracts for difference offer traders additional leverage than regular margin loans allowing traders to achieve a better return on their investment. You ought to also be aware that higher leverage also can result in a rise in risk, this is common with geared products. The leverage accessible for CFD trading is often as much as 100 times whereas margin lenders will generally only offer around 10 times leverage or less. The leverage obtainable will vary between each CFD broker and margin lender. Gearing is often determined on a stock by stock basis taking into account the market capitalization of the stock and liquidity.
As CFDs are an over-the-counter derivative product it is important to note that you don’t own the underlying share or instrument over which the CFD is quoted, this also means that you are not able to move your position to a different CFD company or stock broker, you can only deal with the CFD company which you opened up the position with. If you buy equities on a margin loan the stocks are held in your name which means you are able to move them without restraint from one stock broker to another.
CFDs suit short to medium term active traders seeking to take advantage of market changes in both directions, however, margin lending is much better suited to people who are seeking long-term investment options and want to make the most of the income tax benefits franking credits provide, in addition to voting rights. It’s always essential to remember that both products are geared, you should make sure that you adopt a good money management plan and not utilize the leverage obtainable to its full capacity.
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Tags: CFD, cfd trading, CFDs, contract for difference, contracts for difference