What is the Difference Between Stock Ownership and Stock CFDs?

Introduction

CFD or Contracts for Difference are a form of derivative trading with their values derived from the movement of an underlying asset. With CFDs, traders can trade price movements without the need for owning the underlying asset.

When traders choose to trade CFDs, it means that they are making a contract between broker and themselves. The seller (broker) and the buyer (trader) agree to a contract that speculates on the price of an asset in market conditions. The underlying asset can be a stock, index, currency, commodity, or crypto CFD.

Advantages of Using CFDs

With CFD trading, you don’t buy or sell the physical asset (share, FX pair or commodity). Instead, you buy or sell a fraction of units for a certain financial instrument, depending on either you speculate price going upwards or downwards.

One of the advantages of CFDs is that they offer you a vast range of trading opportunities. There are plenty of asset classes in CFD trading, some are mentioned below:

· Single stocks

· Forex

· Stock indices

· Commodities (metals, energy, etc)

· Bonds

· Options

· Cryptos

Understanding CFD Trading: Leverage and How It Works

CFDs are traded on leverage, meaning you can enter a trade and hold position with a smaller initial capital. This means that you only need to deposit small percentage of the trade value to open a position. This is called ‘trading on margin’ (or margin requirement). While trading on margin allows you to amplify your returns, your potential losses will also be increased as they are dependent on the full value of the position.

Sometimes traders may wish to apply leverage to gain more exposure with minimal equity. Leverage is applied in multiples of the capital invested by the trader such as 2x, 5x, or higher. The broker lends this amount of money to trader at the fixed ratio. Leverage may be applied to both buying (long) or selling (short). When trading with leverage, it is essential to note that profits and losses both will be multiplied.

Trading CFDs on margin typically provide higher leverage than traditional trading. Standard leverage in the CFD market can be as low as 2% margin requirement and as high as 20%. Lower margin requirements mean less capital outlay and greater potential returns for the trader.

CFD trading enables you to sell (short) an instrument if you believe it will fall in value, with the aim of profiting from the predicted downward price move. If your prediction turns out to be correct, you can buy the instrument back at a lower price to make a profit. If you are incorrect and the value rises, you will make a loss on your trade.

CFD trading enables you to sell (short) an instrument if you speculate it will fall in value with the aim of getting returns from the predicted downward movement. If your prediction turns out correct, you buy the instrument again at a lesser price to profit from it.

CFDs are traded over the counter (OTC) via a network of brokers that manage the demand and supply for the CFDs markets. In other words, CFDs are not traded on major exchanges such as New York Stock Exchange NYSE. As mentioned above, the CFD is a contract between trader and broker who are exchanging the different in the initial price of the trade and when the trade is closed.

Mostly CFDs have no fixed expiry dates that means the contract validity is unlimited. A trade is closed only when placed in the opposite direction, meaning you can close a buy trade on 100 CFDs on silver only by selling these CFDs. They are traded in lots (standardized contracts) the size of a single contract varies depending on the underlying asset usually copying how the asset is traded in the market.

What are the different features of CFD trading and stock trading?

Hedging your physical portfolio with CFD trading

If you have already invested in an existing portfolio of physical shares and wonder they would lost value in short term, this is when CFD hedging strategy comes into play. By short selling the same shares as CFDs, you can have an opportunity to make profit from the short-term price decline to hedge against any losses from your existing portfolio.

For example, you hold Apple shares, you could short sell them at the equivalent value of the Apple stocks with CFDs. In case if Apple’s share value falls below in the underlying market, the loss in the value of the underlying physical stock could potentially offset the profit you made by short selling the CFD trade. You have the choice to close out your CFD trade to secure your profit as the short-term decline ends and the value of your physical AAPL stocks continues to rise again

Profit and loss

The profit or loss from a CFD trade results from multiplying the total number of contracts by the contract value of each contract. Then multiplying that number by the difference in points between the price when the contract is opened and when it is closed.

After contract closure you must receive or pay the price difference between the closing value and opening value of the CFD and/or the underlying assets. The CFD provider is obligated to pay you if the difference is positive. if the difference is negative, you need to pay the CFD provider..

Traders should only consider trading CFDs for speculating and hedging for short-term while having considerable market experience during volatile conditions and can bear potential losses. CFDs are not suitable for ‘buy and hold’ trading. CFDs needs traders to keep a constant eye on their positions throughout minutes or hours or days. Maintaining investments overnight increases both your exposure to risk and your additional costs. Stock market volatility and leverage result in fast and significant changes to your overall investment position. You need to take immediate action to handle your risk exposure and add additional margin for protection.

Each investment including CFD trading carries potential risks. The primary risk of every trading is market risk. If the market moves in right direction, you gain returns but if it moves against you, you will end up losing money. CFDs provide leverage which results in significant profits and losses as compared to your initial investment amount, therefore, it is crucial to handle leverage with caution.

The importance of choosing an FCA-authorized broker in UK

The Financial Conduct Authority (FCA) is a renowned Tier-1 regulatory authority in the UK. It is known to be one of the top and most complaint regulatory body due to its strict protocols and dedication in ensuring a secure and reliable trading environment for traders.

FCA regulation acts as shield which protects and verifies that the broker complies with fair and ethical trading standards and participates in the Financial Services Compensation Scheme (FSCS) that protects client deposits up to £85,000 in case it becomes bankrupt.