Articles of Interest

It’s not hard to find blogs and forums where people talk about the benefits of CFDs over shares but have you questioned whether the people actually writing these comparisons are traders who have experience in both financial instruments or are they just paid authors out to promote CFDs. In this quick review we will touch on the differences between both CFDs and shares and highlight the unique aspects of each product that has allowed traders and investors to harness the power of their investment portfolio from the comfort of their own lounge room.

CFDs and shares are very different not only in the way they work but also in how they are traded. One of the fundamental differences is the fact that CFDs are an over the counter or OTC product meaning your transactions are not conducted on an exchange but rather with the CFD provider that you are dealing with. Shares on the other hand are traded on an exchange meaning that you are buying and selling off other people in the market with your stock broker simply acting as a conduit providing you with a gateway to the market.

So now that you know one of the most important fundamental differences between CFDs and shares let’s get into some of the key mechanical differences in detail.

Settlement
One of the most apparent differences between both products is the way in which they are settled. When you buy shares on the stock exchange you don’t have to pay for the share for three days, conversely when you sell shares you do not receive any money for three days. The transaction day plus 3 days or T+3 is the settlement period set by the clearing house not the broker. Of course when trading CFDs there is no clearing house involved as the transaction is OTC this means the your CFD provider essentially sets the rules, as CFD providers typically do not want to wear the risk of having the settlement of a transaction fail they will ask for the money upfront, this concept of same day settlement is known as T+1. It’s worth noting that some online share brokers also apply T+1 settlement to minimise the risk of settlement failure.

There really is no real advantage of T+1 or T+3 settlement as ultimately the net effect is the same, however most active traders prefer same day settlement for the simple reason that it makes their cash flow easier to manage.

Leverage
Unquestionably the most important and apparent difference between CFDs and Shares is the concept of leverage. By the very nature of the instrument CFDs are leveraged meaning that for a relatively small outlay you can obtain a relatively large exposure to a share. Typically the margin rate on most CFDs is around 10% this means that with a margin of $1,000 you could potentially gain $10,000 exposure to the price movement of a share. If you were to buy $10,000 worth of shares you would have to outlay the full amount, rather than the $1,000 required to open your CFD position, providing a more efficient use of capital and return on your initial investment.

It is important to be aware that although leverage can work in your favour, it can also work against you, this means that your profits and your losses are amplified however you can also potentially loose more than your account balance. With share trading on the other hand you cannot lose more than the amount paid, however you profit potential is also reduced.

Short Selling
Equally CFDs and shares can be short sold although the process is often easier with CFDs for the simple reason that short sell transactions can be done online rather than over the telephone. The main reason why short selling shares directly is not a simple process is due to short sale reporting requirements which must 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, essentially this means that they have covered their clients short positions before the client even places the trade.

Costs of Trading
A common myth in the market is that CFDs are cheaper to trade than shares, however this is not always the case. Financing plays an important part in CFD trading however most traders often forget about this. Without conducting any mathematical calculations as a rule of thumb an AUD $100,000 position will cost you around $25 per night in financing, on this basis if you hold a position open for at least 5 days this is the equivalent on paying $125 in brokerage or 12.5 basis points. Of course if you don’t have the capital it may be worth paying this however if the margin of the CFD is high you should think twice as CFD financing is not calculated on the borrowed amount but rather on the full notional value of the position as such it may be more economical to pay for your position outright and pay a higher upfront brokerage cost.

CFDs can of course be a cost efficient trading tool but this is only when positions are held open for a relatively short period of time however, share positions on the other hand can be held open for as long as you like with only the initial transaction cost payable, this is an important difference to keep in mind.

Despite having to pay financing costs one of the benefits of CFDs is that you are not required to pay any GST on your commission, although a relatively small amount it is worth considering the impact of GST on your trading costs if you are an active trader.

Unrealised Profits
As CFDs are marked to market on a daily basis your profits or losses are also debited or credited from your account daily this is very different to trading shares where profits or losses are only realised at the time of sale. In this regard one of the benefits of CFDs is that you can utilise your unrealised profits without having to close your positions, naturally there is also a downside to this in that your losses are realised on a daily basis meaning that unlike share trading the free equity in your account may decline without you closing positions.  

Only five differences have been touched upon in this article, in later articles we will cover some additional differences between shares and CFDs. In the meantime if you would like to find out more interesting information about share and CFD trading you can download our free CFD guide.

Nearly all of the CFD brokers in Australia offer CFDs over the shares making up the ASX top 300, the rationale behind this is straightforward, shares with a larger market capitalization are often far more liquid, however, many CFD brokers forget that we live in Australia, a country full of resources and of course also rich in resource stocks and simply don’t offer CFDs over the small and more speculative mining stocks.

Trading CFDs over speculative mining shares can be very rewarding if you select your stocks carefully. Before trading CFDs over speculative stocks you should perform some research on the company. Before selecting your stocks you should ensure that the company has great management and an excellent project. Needless to say if the copper price has gone up and you happen to be looking for exposure to stocks in this sector logically you wouldn’t select a CFD over a stock with gold assets, this is the reason selecting stocks within the relevant sector is also important. It is always imperative that you remember that trading CFDs over speculative stocks has its risks as these kinds of stocks can go up in price just as fast as they can come down.

So why a trade the CFD instead of buying the Shares outright?

The answer to this question is simple and can be summed up in a few words, unrealized profits and losses. Unlike stocks CFDs are marked to market every day meaning that the profits or losses are credited or deducted to and from your account every single trading day. The profits and losses from buying and selling stocks are dealt with very differently in that they're only realized once the stock is sold. Realizing profits and losses each day means that you are able to use your unrealized to profits to buy new positions without having to deposit further money into your trading account, needless to say the same goes for losses in that you'll have to deposit additional funds into your account if the trade moves against you.

It’s imperative that you note the majority of speculative stocks will have a higher margin prerequisite than shares in the ASX top 300, their margin requirement can easily be as high as 100% however the bulk are offered on a margin of 75%. One critical factor to think about here is whether or not your CFD provider will charge you financing on the full notional worth of the position, this could of course be a fairly large amount if the position was on a 100% margin, there are however some CFD providers that will only charge financing on the borrowed amount. It would be far more cost effective to pick a CFD company which will only charge you on the borrowed amount, if the CFD is on 100% margin this will likely deliver a large cost saving.

You can read more about trading CFDs on small cap mining stocks in this free CFD Guide.

CFD trading is a relatively new concept to most traders and investors in Australia, which is understandable given the mechanics of CFDs are different to traditional share trading. Having an advisor or trading mentor who is able to explain the concept of CFDs and assist you to identify trading opportunities is often a relatively safe way for new CFD traders to gain exposure to financial markets.

There are many stockbrokers and financial advisors in Australia who are able to help traders and investors looking to enter the stock market, however very few have an in-depth experience and understanding of CFDs and how they can be used not only as a hedging tool over a share portfolio but also as a great way to gain exposure to global stocks, commodities, indices and forex pairs.

Some CFD providers are able to provide you with basic CFD trading advice and education however many of them will not provide you with CFD trading recommendations. There are however some CFD providers who are able to provide you with advice and trading recommendations, it is these providers that often also specialise in other aspects of money management including financial planning, corporate advisory and funds management. Dealing with a CFD provider that does not solely specialise in CFD trading is often a good idea for novice traders looking for some assistance in managing their trading portfolio and understanding the risks and benefits CFDs.

Dealing with CFD providers who offer an extensive range of products and services aside from solely offering an online trading platform has a number of advantages in that often you will be assigned a personal account manager with whom you can liaise on a daily basis and ask questions. If you require additional services such as being contacted in the event of a trading idea you can also elect this, however you may be charged a higher commission rate when using this service. Often added benefits such as being able to participate in highly sought after placements and IPO’s will also be provided. 

In many cases getting CFD trading advice from your stock broker or CFD provider will cost more than trading for yourself online, however the added commission charges are relatively insignificant when you consider the benefits and are far cheaper than the looses that many novice traders incur when placing trades without a well thought out trading plan or strategy.

Before trading CFDs either online yourself or with a CFD provider who is able to provide you with CFD trading advice it is essential that you understand not only the benefits of CFD trading but also the risks. Often newbie CFD traders fail to understand that although the leverage associated with CFD trading can result in gains it can also result in large losses, this is why having an understanding of risk management is important.

To learn more about CFD trading it is advisable that you read this free CFD Guide.

There is a common misconception in the CFD industry that commission rates on DMA CFDs are higher than on their Market Made cousins, in this article we will dispel this myth and help you understand the differences between Direct Market Access (DMA) and Market Made CFDs and why this is a common misconception amongst traders and investors.

If you are a CFD trader you will probably already know that there are two types of CFDs, DMA and Market Made, the primary difference being that when trading with a DMA CFD provider your orders flow directly into the underlying market whereas with the Market Made variety your orders are accepted at the discretion of the CFD provider and may not always flow onto the market. Most Market Makers essentially run a book aggregating all of their client’s positions and hedging any resultant outstanding amounts.

The common misconception of pricing has come about due to the fact that DMA CFD providers incurring a cost to hedge their trades. Many people believe that because of this additional hedging cost DMA CFDs are more expensive to trade, however this is not the case. With the advent of electronic order routing DMA execution costs have decreased significantly. DMA cost reductions have been primarily due to brokers competing for market share and the rebates provided by the exchanges for high turnover market participants. With DMA Costs down to 1bps or less it is not surprising that many CFD market makers are now also offering DMA CFDs and hedging risk on their market made book more frequently.

The ultimate beneficiaries of lower hedging costs are the end clients of the CFD provider. As hedging cost decrease your DMA CFD provider is able to pass on these cost reductions to their clients, meaning that today retail traders are able to day trade and scalp DMA CFDs relatively cheaply.

With no real difference in commission between trading DMA CFDs or trading CFDs with a Market Marker it is not surprising that DMA CFDs are gaining in popularity amongst retail traders and professional investors alike. Some DMA CFD providers are even offering commission rates that are lower than those offered by their market made cousins, pioneering a path for the new wave of CFD trader. 

Of course you should always bear in mind that there are advantages and disadvantages of both CFD varieties, it is important determine which variety is more appropriate and suitable for your style of trading. 

You can find out more about trading DMA CFDs in our free CFD Guide.

Day trading contracts for difference (CFDs), stocks or indices, has become popular in recent times. The popularity of day trading has been largely due to numerous advertisements for money making systems, seminars and educational courses that guarantee overnight success. Many of these courses also profess to be low risk and require only a small capital outlay. The truth is, trading is hard work, the more time you devote developing a successful trading plan the more likely it is that you will succeed, however you should be aware that success will not come overnight or without losses.

Once you have put in the time and effort to formulate a trading strategy only then should you consider becoming a professional day trader. Day trading offers many lifestyle benefits including the ability to be your own boss, you no longer need to go into work and take orders from your boss. However, you should not take this freedom for granted, trading should be treated as a business and you must be discipline in order to succeed. If you do not apply discipline to your trading you should not consider trading as a career.

There are significant lifestyle benefits that come with day trading, being you own boss allows you to chose your working hours and even your office, you can work from home or whilst on holidays. Getting into day trading requires little capital outlay as all a Day trader needs is a trading account, computer and internet access. Before you run out and buy yourself a new computer remember that you should also have sufficient funds in your trading account, a common mistake day traders make is that they are undercapitalized when they first start. You should start with at least $20,000 - $30,000 this will allow you to develop and refine your trading strategy and allow you to recover from mistakes. 

The time you spend analyzing and watching the markets will depend the trading strategy that you adopt. Day trading and scalping requires constant monitoring of the market as day traders look to profit from small price movements, whilst swing trading requires that trades be held open for 2-3 days, meaning that you do not need to spend as much time in front of the computer.

Although trading professionally from home allows you to choose your own working hours, it is very important to be aware of key times during the day, in the stock market these are the opening and closing phases of the market, in Australia this is 10am and 4pm. You should also be aware of major overseas market movements and how they affect the local market that you are trading and specific announcements relating to the company’s that you are trading.

Do not believe the promises of guaranteed returns develop and back test your own trading strategies that suit your lifestyle and the time you have to spend on your trading. Trade your strategy and refine it as required, remember you will make mistakes but don’t be disillusioned this is common, simply understand where you went wrong and refine your strategy. Once you have developed a strategy that works for you and suits your lifestyle you will be rewarded with the advantages that being a day trader has.

There are a number of CFD providers that can assist you in getting started, but be sure to choose a CFD provider that is able to offer you a reliable trading platform.

To learn more about trading CFDs from home for a living you should read our free CFD Guide.

Compared to short selling traditional shares, CFDs are a revolution for traders who want to make money in a falling market. Short selling with a traditional stock broker is a complicated and costly process, starting with the brokerage. Generally it is charged at full-service rates to short sell. Traders can spend around $75 a trade to enter a short position in a traditional stock. Short selling shares also attracts a higher margin rate. Generally it requires 25% of the value of the underlying position to go short compared to around 5% with a CFD provider. Short selling with a stockbroker is also dependent on the availability of stocks to borrow. If the stock is not available to short sell the position cannot be taken. If the company decides to recall the stock at any time, then the short position is closed out. Short selling a traditional share is also bound by the downtick rule. This means a trade cannot be taken in a stock unless it is the result of an up-tick in the price activity. In a rapidly falling market going short using CFDs has a big advantage, as short selling traditional shares is prohibited.  

There is a famous saying, ‘markets go up by the stairs and down by the escalator’. This means a rise in prices is likely to take longer than the equivalent size of losses. However a market in a downtrend is often subject to sharp rallies also known as the dead cat bounce. A dead cat bounce in a bear market is usually followed by a resumption of the losses. The bear market rally or dead cat bounce can cause, or can be the result of short covering. This is known as a short squeeze and occurs when short traders close out their positions by buying.

All serious traders must be prepared to go short when the market signals the uptrend is over. Every market will enter a downtrend. No stock will rally always and forever, and every bull market is followed by a bear market. A general bear market will provide abundant shorting opportunities. In a bull market there are fewer shorting opportunities, therefore a trader must be more cautious about taking short positions. As a general rule the safest shorting opportunities in a bull market are on the worst performing stocks in the worst performing sector. Traders earn interest from holding a short position. This is a consideration if a trader wants to have a short position for the long term. For example, long term corrections on stocks like Telstra, AMP, Lend Lease provide traders with extra income on top of the profits as a result of the falling price.

Example – short position in Telstra Corporation (TLS)
On 24 June 2010 you believes TLS is in a downtrend and take a short position in TLS share CFDs. You decide to hold the position using a 50c trailing stop loss.

Opening the position

Telstra Corporation is quoted by your CFD provider at $3.13 bid.

You sell 10,000 Telstra share CFDs at $3.13. The total value of the trade is:
$3.13 x 10,000 = $31,300

The margin required to open the position is 10% of the total value of the trade and is calculated as follows:
$31,300 x 10% = $3130.00
    
Whist short you will earn interest on the trade at a rate of 3.24% per day calculated as follows:
$31,300 x 3.25% / 365 = $2.78 per day*
    
*This will vary according to the daily closing price of TLS

Closing the position

Telstra Corporation makes lows of $2.25 in August. A stop is then moved down 50c above this level at $2.75. The market does not go any lower before reaching the level of $2.20 on 24 August.

You now buy 10,000 TLS share CFDs at $2.20. Profit is calculated as:
($3.13 – $2.20) x 10,000 = $9,300

The position earns interest of $2.78 per day for two months:
$2.78 x 60days = $166.80 approx

Your total profit on the trade is:  
$9,300 + $166.80 = $9,466.80 approx*

*should the position have moved against you, you would have incurred a loss on the trade.

You can find out more about how you can use CFDs to short sell in our free CFD Guide.

What is a CFD?
Contracts for difference are a popular derivative in the Australian market place. When you own a contract for difference, you own a contract over the difference between the price that you purchased the contract for and the current price of the contract, ie you own a contract over the performance of the share.  That is, if you buy a CFD at $1.43 and the price rises to $1.55, then your contract is for the difference between the purchase price of $1.43 and the current price of $1.55, which is 12 cents in profit.  If the CFD had decreased in value, then you would be obliged to pay the difference between the purchase price and the current price.  Rather than buying the shares, you buy a contract over the movement in the share price and this is revalued or “marked to market” in real time.

A CFD offers you all the benefits of trading shares without having to physically own them.  It is a contract that mirrors the performance of a share or index, is traded on margin, and like physical shares your profit or loss is determined by the difference between the prices you buy and sell at. CFDs also incorporate any adjustments for corporate actions, such as dividends and stock splits.

What are the benefits of CFDs?
CFD’s are traded on margin, which is a more efficient use of your capital because you only have to allocate a small proportion of the value of your position to secure a trade, whilst still maintaining full exposure to the market. In effect you are able to magnify the returns on your investment. The commission charged by CFD providers is low, usually around $10 or 0.1%, this means that you don’t have to pay high priced brokerage on either long or short transactions.

Because you are trading the price movement of a share or index without physically owning it, it is as easy to sell a share or index CFD, as it is to buy it. Therefore a CFD trader has the opportunity to profit from both bull and bear markets as well as short-term intra-day movements.

Just as CFDs mirror the price movement of the physical share market, they also mirror any corporate actions that take place in the underlying share or index (dividends, stock splits or consolidations). This means that the owner of a share CFD will receive dividends, and participate in stock splits, just as they would if they owned the physical share.  It also means that if a share goes ex-dividend (meaning a dividend is due to be paid) while you are short a stock, then you are obliged to pay the dividend in the same way as if you were short the physical stock. When owning a CFD you are not entitled to any voting rights because you do not actually own the underlying shares.

Short Selling
Short selling using CFDs is the same as selling CFDs that you already own. Generally there are no restrictions on how you transact the CFDs or on the number of short sellable CFDs. You can short sell any available CFD however some CFD providers may have a restricted short sell list or restrictions on the amount of a stock that can be short sold. With CFDs you don’t have any short selling restrictions like the uptick rule with shares. This provides significant advantages over the traditional techniques of short selling.

Instruments on which CFDs are offered
Most CFD providers offer CFDs over the major sectors, major share indices and stocks in the major share indices of the major markets. Many CFD providers offer thousands of different instruments in Australia, Asia, the UK, Europe and America.

Costs associated with CFD trading
There is a small commission cost to open a CFD position, the price of a CFD is the same as that of the underlying stock or index on the stock market. This means that purchasing a CFD is the same as purchasing the underlying stock except for the low cost of brokerage, which makes CFD trading ideal for people with low account balances. 

CFD positions carried overnight incur financing costs for the total value of the position.  Traders who are long Australian CFDs will pay interest and those who are short will receive interest on their positions. The interest rate payable is based on the cash rate for the country in which the stock is listed. If the base interest rate of a country is less than the financing cost charged by the CFD provider for going short no interest will be charged on short positions. An example of this is in Japan where interest rates are close to 0%. In this case no interest is chargeable on short CFD positions.

If you hold a CFD overnight, you are charged interest on the total value of the position, this is because the CFD provider hedges your position by financing the purchase of the underlying stock in the market. They then pass on the interest to you the client at a premium.  The interest rate charged depends on the market that is being traded. If you are short a CFD you will receive interest on the full value of your position for every day that you hold your position overnight.  If you have a well-balanced trading system where you are short and long for around the same amount of time, you will effectively only pay only a small interest charge for overnight positions. 

You can find our more about CFD trading in our free CFD Guide.

Benefits of trading CFDs
CFDs are derivative products that offer distinct benefits including:

Liquidity
CFD prices are obtained directly from the underlying market. This means CFDs give you access to the liquidity in the underlying market, plus liquidity offered by the CFD provider. Most of the time there is much more liquidity in the CFD market than in the underlying or physical market due to the higher number of participants including private and institutional traders.

Trade on margin
CFDs are traded on margin, typically from 5-10% to for shares and 1% for indices. This means a more efficient use of your capital as you only need to allocate a small percentage of your funds to secure a trade. This also enables you to magnify the returns on your investment with a much smaller capital outlay.

Trade long and short
Before CFDs, going short a stock could only be done through a traditional broker that would charge hefty fees on top of the normal brokerage. With CFDs traders can now go short any position or market without any extra cost. Going short is as easy as going long with CFDs. Going short also provides another benefit that was not available before. Your CFD provider will pay you interest on a short CFD position. This is similar to earning interest on your bank account balance.

Trade on-line
With an estimated 13.4 million Australians with Internet access online share trading has also been on the increase, giving traders more control and constant access to their positions. Most CFD providers offer free software and CFD trading platforms that allow traders to place orders online even outside normal trading hours.

Low transaction cost
Trading CFDs can cost you as low as $10 each way compared to traditional stock brokerage rates of around $25-30. Although transaction costs are a small portion of your overall trading cost, they have an impact on your bottom line once the volume of your transactions increases.

Access to international markets
CFDs open up a wide range of trading instruments. Most CFD providers offer CFDs on Australian and International shares, indices, sectors, commodities, foreign exchange and treasuries. Most of these markets were not available or accessible to private traders before due to the complex nature or complicated set up of traditional brokerage accounts.

Receive benefits of dividends and stock splits
As CFDs reflect the price and movement of the underlying physical share, they also mirror any corporate actions that take place in the underlying share. This means, if you are a holder of a share CFD, you will also receive dividends and stock split benefits once they become due. However, you are not entitled to any voting rights or franking credits. On the same vein, when you are short a share CFD and the underlying stock goes ex-dividend, you have to pay the dividend amount as you would if you were short the physical share.

To find more helpful CFD trading tips you can download our free CFD Guide.