In the early days investors needing to borrow money to trade had few choices, either borrow money from your bank to purchase shares or call up your stockbroker and apply for a margin loan.
In 2003 traders and investors in Australia got a further choice, CFDs. Since their introduction the industry has changed, CFDs being a simple form of margin lending have grown to be the fastest growing derivative product in the country, outstripping the growth seen in the warrants market during the mid 1990’s.
No longer does a retail investor need to apply for a bank loan or deal with costly full service brokers. CFDs have revolutionized the financial services industry, retail investors can now open a Contract for difference account on-line in minutes and be up and trading before the conclusion of the day, executing all of their orders in real-time over the internet.
Unlike margin lending CFDs are usually traded over the internet with the investors portfolio being marked to market in real-time during the trading day, this is substantially different to the end of day portfolio revaluations employed by margin lenders. Real time portfolio margining means that traders can properly accurately manage risk during the trading day rather then needing to wait for statements to be created at the conclusion of the trading day.
Similar to equities bought using a margin loan CFDs also offer the holder the capability to receive a dividend, however in the majority of cases franking credits aren’t passed on to the holder of a Contract for difference unlike that of a margin loan. The main reason franking credits aren’t passed on when holding a CFD is because the purchaser of a CFD holds an over-the-counter derivative contract and not the real share. Not having the physical share whilst owning a CFD position also means that the owner of the CFD isn’t entitled to voting rights in the listed corporation over which the Contract for difference is based. Numerous CFD traders only hold their positions open for a short time frame and are not interested in voting rights or franking credits but instead have an interest in making a return from the short term price changes of the CFD.
One of the most significant advantages of Contracts for difference is that traders can always sell them as easily as they are able to buy them, this means is that going long is just as straightforward as going short allowing traders to gain in falling markets. With traditional margin lending short selling is tricky and near impossible.
CFDs are comparatively cheap compared to margin lending, typical brokers offering margin lending will charge 0.50 percent whereas a normal CFD provider will charge 0.10 percent. One thing to be cautious of are the interest levels charged by margin lenders and CFD providers. It’s vital to note that margin lenders will charge interest only over the quantity borrowed whereas Contract for difference providers will charge interest on the full notional worth of the position, however, CFD financing charges tend to be lower. Financing rates are essential to take into account when comparing both products, however, this is less important for Contract for difference traders that only hold their positions for a short period of time.
Typically Contracts for difference offer traders extra leverage than regular margin loans enabling traders to obtain a superior return on their investment. You ought to also be aware that higher leverage also can lead to a rise in risk, this is normal with leveraged products. The leverage offered for CFD buying and selling can be as much as 100 times while margin lenders will normally only offer around 10 times leverage or less. The leverage obtainable will vary between each CFD provider and margin lender. Leverage is often determined on a stock by stock basis taking into account the market capitalization of the stock and liquidity.
As Contracts for difference are an over-the-counter derivative product it is important to note that you do not own the underlying share or instrument over which the CFD is quoted, this also means that you are not able to transfer your position to a different Contract for difference broker or stock broker, you can only deal with the Contract for difference provider that you opened the position with. Whenever you buy stocks on a margin loan the equities are held in your name this means that you can always move them without restraint from one stock broker to another.
CFDs suit short to medium term active traders seeking to exploit market movements in both directions, however, margin lending is much better suited to people who are looking long-term investment options and wish to take advantage of the income tax benefits franking credits provide, as well as voting rights. It’s always essential to keep in mind that both products are leveraged, you must make sure that you adopt a suitable money management plan and never utilize the leverage offered to its full capacity.
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