Welcome to SharpDeal’s Education Center. Whether you are just beginning to trade or you are a seasoned investor looking for new trading strategies, this Centre provides a wealth of information on the most relevant topics.
We will start by talking about some of the basic features of CFDs including some of their advantages and shortcomings compared to traditional stocks.
Contracts for Difference are a stock derivative product that enables investors to participate in the price movement of an underlying stock or stock index without taking ownership of the underlying instrument itself.
CFDs offer some important advantages over traditional stocks that make them particularly interesting to short-term traders.
CFDs can be traded directly on live (un-delayed) tradable prices, while conventional stocks often require you to establish an exchange agreement to trade on live stock prices.
A CFD price behaves exactly the same as the underlying stock price, but often the trading fee is already added to the Bid/Ask spread. In many cases, this is the only ‘fee’ you pay for trading the CFDs, so you know exactly what your profit or loss is, including trading fees, when you close positions.
Margin trading allows you to magnify small intra-day price swings by depositing a fraction of the trade value in collateral. Margin rates vary between CFD providers;
Of course, margin trading can work against you as easily as for you, and while profits can be magnified so can losses. You should use leverage with caution.
CFDs also offer the advantage that you can short sell a stock to take advantage of downward price movements as easily as buying the stock (going long). Executing a short sell is done in exactly the same way as a long trade and can be done on a live tradable price quote.
Short selling a stock CFD is subject to specific rules in some countries.
CFDs also hold the advantage that they are not subject to a number of costs that traditional stocks are subject to:
Most stock trading establishments charge a yearly custodian fee for holding foreign stocks to cover the administration of holding the stock for you. Additionally, you may also have to pay cross-board transfers for stocks and for other corporate action such as dividends and stock splits. CFDs are not subject to these costs, but are faster and more convenient to trade than physical stocks.
As you are not physically buying stock, in many countries profits from CFDs are currently not subject to the same taxation as profits from stocks. This is one of the major contributing factors to the popularity of CFDs in some countries.
If you hold a long CFD position on Ex-Dividend Day, you receive dividends for that CFD in the same way as if you held the stock. So when leveraging your stock investment on margin, you magnify dividend payments as well as price swings for the stock.
Note that if you are holding a short CFD position, you will be obliged to pay dividends on your position.
When you buy a CFD, you are effectively borrowing money to pay for the CFD and you own money is there only to cover potential losses from the CFD position. For long CFD positions held past the end of the day’s trading on the exchange, you pay overnight interest on the amount borrowed and this must be taken into consideration. In reality, this can make CFDs suitable mostly for short-term positions as longer term, financing costs can eat into potential profits.
CFD positions closed before the end of day on an exchange are not subject to overnight financing charges, and CFDs are therefore well suited to intra-day trading.
Short CFD positions carry no financing charge and you may even receive a small interest component.
Trading foreign exchange and futures on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange or futures you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange- and futures trading, and seek advice from an independent financial advisor if you have any doubts.
Any SharpDeal advice is general advice only.