When it comes to trading shares, there are so many ways for you to make money. You can trade everything, including commodities, forex, currencies and so much more. You can also trade without even owning the share in question. This is called a CFD and this article will explain the differences between trading CFDs and shares.
What is a CFD?
A CFD is a type of derivative. Derivatives are basically contracts agreed between parties that derive their value from their relationship with an underlying asset or group of assets. CFD stands for Contract For Difference. With a CFD, you don’t actually need to own a share to make money from it. The ‘contract’ in question is the contract you have between you and the CFD provider. The ‘difference’ in this contract is the difference between the value of the share at the opening of the contract and the value when the contract is closed. For example, if you bought the CFD of a share that went up in price from $5 to $7, then you would make $2 from the difference. If you would like more information on what a CFD is, then go to learncfds.com.
Leverage
The main way that CFDs differ from shares is that the amount of money you have to spend is much lower. Leverage concerns the amount of margin you are allowed when trading in shares. Your margin is the amount that you have to spend – a 60% margin would mean that you would have to come up with 60% of the total value of the shares you were buying and then you could borrow the rest from the broker. CFDs have a far lower margin of 5%. This means that you only have to spend 5% of the price of the share to start trading the CFD.
On a trading account, you will often have a limit on how you can spend – for example, you might have a limit of $10,000. If you were buying normal shares then you would only be able to buy shares up to $10,000 in total value, whereas with CFDs, you can spend far less to trade far more.
Fees
Another major difference between shares and CFDs is the fees and commissions that you have to pay when trading them. With shares, you have to pay a high commission fee to the broker you are dealing with, on top of the high margin. With CFDs, you only have to pay a comparatively smaller fee to the platform that you are trading on.
Hedging
This is something that you can combine share and CFD trading together to do. Hedging is when traders and companies protect their share investment from market downturns. You can short with CFD trading to protect your bought shares. It works by you trading the CFD of the shares you own so that when the value of the shares drops, you do not experience a loss because the CFD will offset the fall in the value of the share. As the share falls in value, the CFD will earn you the exact same amount of money because it is derived from the difference between the price at the beginning and the price at the end.