Articles of Interest

The first thing to remember is that trading is not a level playing field. Professional traders have a lot of advantages over the private trader. Despite the accessibility and availability of CFDs to retail investors nowadays, in general, the pros still win more often than the non-pro traders. Why?

The pros have:
Better access and information flow – fund managers and institutional players spend significant amount of money to access market information. Most of these institutions are backed by large teams of researchers and analysts who constantly monitor the market. Professionals will almost certainly have a lot more information at their fingertips (or at the end of a telephone) than private traders. They will know a lot of people in the market and can formulate views by speaking to others.

Work as part of a team – institutional players usually have researchers, analysts and other market specialists that work as a team to maximise profitability. The typical private trader is just that – a single person. There is nothing wrong with that of course, but a private trader has to do everything from making the tea to executing the trades. Often working in a team can help professional traders – much of the work can be delegated.

Huge amounts of capital – This is of course the single biggest advantage that a professional has. Often the money is not their own and that can make trading easier on occasions. Due to the nature of their business, fund managers and other institutional traders have easy access to millions of dollars of external capital not available to retail traders.

While institutional traders and fund managers have inherent advantages over retail traders, there are ways to level the playing field. If you are to treat CFD trading as a business (as you should), you must ensure that:

You have enough capital – There’s a well-known saying among traders that goes: “Don’t trade with money you cannot afford to lose.” Sometimes this is called ‘scared money’. If you are to trade (CFDs or any other instrument), make sure that you have enough capital and that you are not trading with money you are not prepared to lose.

You get real time charts and other tools – Access to information is vital in trading. You have to know what is happening in the market particularly if there’s a lot of volatility that may provide profitable trading opportunities. You have to know the exact price movements to be able to trade the trend. End-of-day data download will be useless if you’re trying to catch intra-day price movements.

You have the fastest Internet access you can afford – Broadband access has never been more affordable, so take advantage of this technology to enhance your trading.

You pay lower/lowest commission – Commission is a business expense and must be kept to the minimum. Even large institutional traders seek ways to pay the lowest available commissions.

You have a fast computer – Prices of computers have gone down considerably and you only need to spend a few hundred dollars to have a fast computer with enough power and storage capacity. Invest in a reliable computer and do not let technology get in the way of your trading profitability.

You use a professional research service – While you could have an information overload given the amount of information readily available on the Internet and other sources, it is wise to use a reliable research or newsletter service that may provide some guidance on specific trades or markets. Use these research services as a starting point to do your own research.

You can find out more about how to trade CFDs 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.