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.

A common question people ask is ‘do I receive dividends when buying CFDs?’ The answer to this question is simple, ‘yes’. However, there are a few things to be aware of as CFDs are a derivative contract between the CFD provider and the buyer or seller of the CFD, you do not own the underlying share over which the CFD is based, this means that the treatment of dividends may be a little different to what you may have become accustomed to when trading shares.

Unlike ordinary shares the dividends received by the holder of a long CFD position do not have any franking credits attached to them. A franking credit is a tax credit provided by the company with the dividend when it is paid to shareholders.  Essentially the company over which the CFD is based has paid a portion of tax on behalf of its shareholders. Fully franked dividends have a 30% tax credit attached. The concept of franking credits is peculiar to Australian companies. 

When buying shares it is important to understand that in order to be entitled to the dividend franking credits it is necessary to own the shares for 47 days which includes the dividend date. The formal requirement is 45 days but this doesn’t include the days the shares are bought or sold which increases the holding period by an extra two days. Despite franking credits not being attached to CFDs most CFD traders are not concerned as most are not long term investors and do not hold their CFD positions open long enough to gain any real benefit.

CFD traders can sell a CFD just as easily as they can buy a CFD, selling a CFD without holding a long open position is known as short selling. It is important to note that there is an obligation to pay a dividend to the CFD provider when a short sold CFD position is held over the ex-date. The ex-date is the date on which the seller, and not the buyer, of a stock is entitled to the dividend. 

It is important to be aware that when paying the dividend on a short sold position you may also be liable to pay the franked component of the dividend. The reason you may be liable to pay the franked component in addition to the declared dividend amount is because when your CFD provider hedges your short position in the market they were required to borrow stock from an owner of the shares, it is possible that they borrowed the stock to cover your short position from another Australian resident who is also entitled to the franking credit. In most cases your CFD provider will attempt to secure stock from offshore where the owners of the stock have no use for franking credits. You should always check with your CFD provider prior to short selling a CFD over dividend periods as you may find that you are also liable to pay the franked component of the dividend.

There are a number of trading strategies CFD traders can employ over dividend periods, one of these strategies is known as dividend stripping. Dividend stripping is the purchase of shares prior to a dividend being paid, and the sale of those shares after that payment. Understanding how you can trade CFDs around dividend periods is important when developing your CFD trading strategies. 

To find out more about CFD trading you can download our free CFD Guide.

Settling (Paying for) your trades?
Prior to placing an order through your online trading account you must ensure that you have enough money in your account to cover the total cost of the transaction as soon as your buy order is placed. On the settlement day (T+3) your broker will debit the cost of the trade from your trading account. Over the settlement period funds are locked and cannot be withdrawn from your trading account for any purpose.

When do you receive the proceeds from selling your shares?
Your trading account will be credited with the proceeds from the sale on the 3rd business day after the trade.

Are there any software or data fee charges?
Some online brokers will charge a platform fee, generally platform fees are payable monthly in arrears, with the charge being deducted from your online trading account at the same time.

What Identification do you need in order to open an account?
Generally online brokers require that each person named on the account opening forms are required to provide two forms of identification when opening an account, this is usually a copy of your drivers licence and passport.

Do you need to maintain a minimum balance?
You do not have to maintain a minimum account balance, nor make an initial deposit into your trading account.

How do you transfer money into your account?
Once your account has been opened, you will receive details of your account number and also instructions as to how you are able to deposit funds. The most common methods of depositing funds are Bpay, Online bank transfer or Cheque.

How do you withdraw money from your account?
You can withdraw money from your online trading account by directly faxing a withdrawal request to your online broker.

Will you receive account statements?
As the holder of an online trading account you will receive daily, monthly and quarterly statements showing movements into and out of your account. Your statements will also show any interest earned and credited to your trading account. You can view the balance of your account along with your open positions at any time online.

Will my account balance earn interest?
Most brokers will pay you interest on the balance in your trading account at the market rate. Interest is calculated daily and generally credited to your account monthly or quarterly.
 
How long will it take for my trading account to be opened?
Once your broker receives your account application and identification generally your account will be opened within 24 hours.
 
Will you be told when your account has been opened?
Yes, your broker will send you a welcome email outlining your online trading platform log in details.
 
What is CHESS?
CHESS (Clearing House Electronic Subregister System) is the computerised share registry and settlement system owned and operated by the ASX. CHESS manages all of the share ownership records of ASX listed companies.

What is a HIN?
A HIN (Holder Identification Number) is the number used by CHESS to identify individual clients when they become sponsored by a particular broker. Each person is issued with a HIN when their account is opened. All of the shares you purchase will be attached to your HIN, this makes it easier to manage your share holdings and transfer them to another broker if required.
 
Can you have multiple HINs with a number of different brokers?
Yes, although you would not be able to sell holdings through the broker where you have an account if they are held under a HIN with a different broker.
 
What correspondence will you receive?
Every time you trade, you will receive a trade confirmation on the platform and from us. Each month you will also receive holding statements from CHESS, detailing any change to your holding of an individual stock during the previous month.

How do you sell your shares?
Before you can sell your share portfolio, you will need to transfer or convert your stocks to CHESS. To transfer shares from another sponsoring broker, you will need to complete a form to change your sponsoring broker. Once the transfer is complete, you will be able to view your holdings through your trading platform. You will then be able to sell your shares through your broker online. Any additional share purchases will automatically be registered with CHESS and will be available for immediate sale though your broker.

How do you transfer your holdings from another broker?
When you open an online trading account, it is possible to transfer your HIN from your new broker. This means that all holdings under your existing HIN will be transferred to your new broker (this process usually takes up to 48 hours). If there are any outstanding orders or unsettled trades with your existing broker, your HIN cannot be transferred until all outstanding orders have been settled. You will need to complete the Sponsoring Broker transfer form to transfer your HIN. 

Can you transfer part of your holdings?
It is possible to transfer only some of your holdings by using the Sponsoring Broker transfer form and and listing the stocks and quantities you want transferred.

Can you sell Issuer Sponsored stock?
No, all stock must be converted to your chess holdings before you are able to sell it.

You can read more about share trading and how you can build a trading plan in our free Shares Guide.