Traditional stock trading allows the trader to buy or sell an asset, whilst gaining full ownership of the underlying asset and you can sell it to another trader at your will. But the instances are different in CFD Trading. You don’t get to own the underlying asset but you can speculate on its price movement and you can also buy or sell the contract. Talking about the contract, this is an agreement between both the CFD provider and the trader. Although traditional trading and CFD trading are quite similar in most cases, there are some differences that must be noted.
In CFD, the trader secures an agreement with the broker to trade the underlying asset without owning it. The difference between the opening and closing price will also be paid at the end of every trading day.
In CFD, the margin is being used. This margin is like the money you borrow from your broker. Margin is used to leverage your trading funds and therefore, you can open a larger trading position with the minimum capital that you have.
In CFD trading, you are relieved from paying UK stamp duty which is 0.5% of your earnings.
As for traditional stock trading, you can buy or sell stocks after paying their full amount. You are also set to deliver the underlying asset.
How Much Money Do You Need To Trade?
Brokers are following different rules that vary from one platform to another. But generally speaking, we can say that one contract for difference is equal to one share if you are doing share trading. But in CFD, you will not be required to have huge funds to open a trading position. Most of the time, you will only be required to pay 5% to 20% of the full value of the underlying asset.
That being said, that 5% margin equals more chances to open other positions. You can get as much as 20x higher exposure compared to traditional shares trading. For instance, you buy 5 shares worth $200. In traditional trading, you will be asked to pay $1000 to start trading. However, if you buy shares on CFD with the same amount and the margin is 10%, you will only be required to pay $100 to open a trade. The rest of your money, you can use to open more positions. This means that you have 10x higher chances of profit.
The disadvantage of CFD Trading
You may already have the urge to start trading CFDs now that you’ve known how powerful leverage is. But don’t get too excited. Leverage also has its own set of advantages that must not be taken lightly. Leverage is a double-edged sword. Your gains are mirrored and your losses as well. When you use leverage, even the smallest price movement can affect the trader’s capital.
Aside from leverage, you also get subjected to counterparty risks in CFD trading. This is because you do not own the underlying asset but only the contract. It is therefore very important to pick a reliable CFD broker that is licensed and regulated.
Leverage is the number one advantage of CFD but it can also turn into the biggest disadvantage if not used properly. CFD is known as leveraged products wherein, traders get to trade on margin and don’t require tying up the full value of the asset. Leverage is also available for share trading but the leverage is much lower compared to other markets. It is also very rare to see traders leveraging on share trading compared to if you do it with CFD.
Leverage is such a useful tool, especially for retail traders. You can access a larger position through leverage and you can also expect larger gains whenever the market goes in your favor. But it is important to note that as much as leverage mirrors gains, it also mirrors losses once the market goes against your predictions. Taking these things into account, it is very important for you to know how to manage the risks if you use leverage on your trades.
Now that you’ve known something important about CFD, it is time to know the advantages of Stocks CFD trading. You can trade long and short positions in CFD trading and you are also not required to deliver the asset when short selling trade.