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In the early days investors wanting to borrow capital to make investments had few options, either borrow funds from your bank to buy equities or phone your stockbroker and apply for a margin loan.
In 2003 traders and investors in Australia got an extra choice, CFDs. Since their introduction the industry has changed, CFDs being a simple type of margin lending have turned out to be the fastest growing derivative product in the country, outstripping the growth experienced 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 stockbrokers. CFDs have revolutionized the financial services industry, retail investors can now open a CFD account over the internet in minutes and be up and trading before the conclusion of the day, executing all of their orders in real-time on the web.
Unlike margin lending CFDs are usually traded over the web with the trader’s portfolio being marked to market in real-time throughout 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 correctly manage risk during the trading day instead of needing to wait for statements to be produced at the conclusion of the trading day.
Similar to shares bought using a margin loan CFDs also offer the holder the ability to receive a dividend, however in most circumstances franking credits aren’t passed on to the holder of a CFD unlike that of a margin loan. The main reason franking credits are not passed on when holding a CFD is because the owner of a CFD holds an over-the-counter derivative contract and not the physical share. Not having the physical share whilst owning a CFD position also means that the purchaser of the Contract for difference is not entitled to voting rights in the listed corporation over which the Contract for difference is quoted. A lot of Contract for difference traders only hold their positions open for a small time frame and aren’t interested in voting rights or franking credits but instead are interested in making a return from the short term price changes of the Contract for difference.
One of the most important advantages of CFDs is that traders can always sell them just as easily as they can buy them, this means is that going long is just as straightforward as going short allowing traders to gain in falling markets. With conventional margin lending short selling is complicated and near impossible.
Contracts for difference are relatively inexpensive in comparison to margin lending, typical brokers offering margin lending will charge 0.50 percent whereas a typical CFD provider will charge 0.10 percent. One thing to be cautious of are the rates of interest charged by margin lenders and Contract for difference companies. It is important to note that margin lenders will charge interest only over the quantity borrowed whereas Contract for difference companies will charge interest on the complete notional value of the position, however, CFD financing charges are typically lower. Financing rates are imperative to consider 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.
Generally Contracts for difference offer traders added leverage than regular margin loans enabling traders to obtain a better return on their investment. You should also be aware that higher leverage can also result in an increase in risk, this is normal with leveraged products. The leverage accessible for CFD trading is often as much as 100 times while margin lenders will commonly only offer approximately 10 times leverage or less. The leverage offered will vary between each Contract for difference company and margin lender. Gearing is usually determined on a stock by stock basis considering 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 based, this also means that you can’t move your position to another Contract for difference provider or stock broker, you are only able to deal with the Contract for difference broker that you opened the position with. Whenever you buy shares on a margin loan the stocks are held in your name this means that you are able to move them freely from one stock broker to another.
CFDs suit short to medium term active traders seeking to make the most of market movements in both directions, however, margin lending is much better suited to people who are looking long-term investment options and wish to benefit from the tax benefits franking credits offer, along with voting rights. It’s imperative to keep in mind that both products are geared, you need to ensure that you adopt a suitable money management plan and not utilize the leverage offered to its full capacity.
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