Investors who participate in the financial markets are increasingly looking for ways to diversify their portfolios. While many of them are familiar with instruments such as shares and bonds, not as many understand the workings of derivatives such as CFDs. If you are interested in trading both shares and CFDs, this article will provide you with basic information about the two instruments.
What is share trading?
Share trading is the activity of buying and selling shares with the objective of earning a profit. You can trade shares through a stockbroker or using online trading software. To begin trading, you transfer funds from your bank account to your share trading account and purchase the shares you have chosen to invest in and cover all costs involved.
You buy shares of a company hoping that the company, and thus its shares, will rise in value so that you sell them later at a price higher than what you bought them for. Dividends are another way to make money from shares. When you buy shares of a given company, you are eligible to receive a dividend (a portion of the company’s profits) at the end of the company’s financial year or when the company announces dividend payments.
What is CFD trading?
The popularity of CFD trading is growing across major financial markets and across a wide variety of investors.
CFDs (Contracts For Difference) are a derivative product. A derivative is a financial instrument that obtains its value from the value of an underlying asset. CFDs are cost efficient and transparent derivatives, which makes them a great option for tailoring trading strategies. CFD trading is the buying and selling of CFDs. It enables an investor to speculate on price movements of financial instruments like shares, indices, commodities, and forex.
How CFD trading works
When you trade a CFD, you agree to exchange the difference in the price of an underlying asset from when the CFD contract is opened to when it’s closed. You can speculate on upward or downward movement of the underlying asset’s price. Your profit or loss is dependent on the extent to which your prediction or forecast is correct. If you speculate on a price increase and it happens as so, you make a profit. If the asset’s price moves in contrast to your forecast, however, you make a loss.
For example, if you think that Huawei shares are going to fall in price, you could sell a share CFD on Huawei. You will earn a profit if the share’s price drops and a loss if the shares increase in value. Profits and losses on CFDs are realized when your position is closed.
You require less capital upfront to trade CFDs because it is a leveraged product. You only put up a percentage (called a margin) of the underlying asset value. This allows you to get an exposure equivalent to what you would get trading the actual asset but for less money. It is important to remember that the same way leverage can magnify your profits if can magnify your losses.
Differences between share trading and CFD trading
- CFD trading enables you to trade a vast variety of financial instruments including shares, indices, commodities and forex while share trading limits you to shares and ETFs (Exchange Traded Funds).
- In CFD trading, you can use leverage to spread your capital and amplify profits because you don’t pay for the full value of the underlying asset. In share trading you pay up front the full value of the shares you want to invest in, which means you cannot spread your capital as much as you can with CFDs.
- It is possible for losses to exceed your initial deposit when trading CFDs while in share trading you limit risk to your initial capital outlay.
- CFD trading allows you to go long or short on the market’s direction while shares are only traded on rising prices. This means in share trading you only benefit when share prices go up.
- You can trade CFDs round the clock. Trading shares is possible only when stock exchanges are open.
- Share trading comes with shareholder privileges (such as voting rights). You don’t receive any shareholder rights or privileges when trading CFDs.
CFDs and shares offer unique benefits. Your investment objectives should guide you on which instruments to invest in at a given time in your investment journey. With a better understanding of CFDs and shares, you are now in a better position to make an informed decision.