CFDs And Margin Lending: What Are The Differences?
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It was only until recently that investors wanting to gain additional exposure to the share market had the choice of either borrowing money from the bank of applying for a margin loan.
CFDs were introduced to Australia in 2003 and their introduction changed the industry forever. CFDs are the fastest growing derivative product in Australia, the growth rate over the last 7 years has been greater than the growth of any derivative product in history.
With CFDs retail investors do not need to apply for a bank loan or deal with their full service broker. CFD providers now allow retail investors to open up an account on-line in minutes and start trading on the same day. CFDs are executed on-line in real time, their efficiencies have revolutionised the on-line trading industry.
Trading CFDs on-line has advantages over traditional margin loans. CFD portfolios are marked to market in real time within the CFD trader's on-line platform allowing the trader to manage their risk on an intra-day basis. Typically margin lenders will provide portfolio reports on an end of day basis meaning the trader must constantly maintain a significant cash buffer in the their trading account to cater for market moves.
Like shares bought using a margin loan CFDs also offer the holder the ability to receive a dividend, however in most cases franking credits are not passed on the holder of a CFD unlike that that of a margin loan. The 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 owning the physical share when holding a CFD position also means that the owner of the CFD is not entitled to voting rights in the listed company over which the CFD is based. Many CFD traders only hold their positions for a short period of time and are not interested in voting or franking credits but instead are interested in making a profit from the short term price changes of the CFD.
Unlike shares bought on a margin loan CFDs can be bought and sold with ease. Being able to short sell CFDs gives the CFD trader a significant advantage over the holder of a margin loan. Short selling allows traders the ability to profit when markets are in a down trend.
CFDs are relatively cheap when compared to margin lending, typical brokers offering margin loans will charge 0.50 percent whereas a typical CFD provider will charge 0.10 percent. One thing to be wary of is the interest rates charged by margin lenders and CFD providers. It is important to note that margin lenders will charge interest on the amount borrowed whereas CFD providers will charge interest on the full notional value of the position, however CFD financing rates tend to be lower. Financing rates are an important cost to consider when comparing both products however this less important for CFD traders that only hold their positions open for a short period of time.
CFD traders are able to earn a better return on their capital outlay as the leverage offered by CFD providers is often more than that offered by margin lenders. It is important to note that although leverage can result in an increase in returns it also results in an increase in risk. Some CFD providers offer leverage as high as 100 times whereas most margin lenders will only offer around 10 times leverage or less. The leverage offered by CFD providers and margin lenders vary's and is determined by the liquidity and market capitalisation of the stock which the CFD is offered over.
As CFDs are an over-the-counter derivative contract you do not own the share over which the CFD is based, this means that you cannot transfer your position to another CFD provider or broker, you must close the position with the CFD provider that you opened it with. On the other hand shares bought on a margin loan can be transferred from one broker to another, this is simply because the holder of the margin loan owns the actual share.
Margin loans and CFDs are suited to different kinds of traders and investors. Margin loans are better suited to longer term traders looking to take advantage of dividends and franking credits whereas CFDs are suited to frequent traders look to take advantage of small price movements whichever way the market heads. As both CFD and margin loans involve leverage it is important that you adopt a strict risk management plan to ensure that you do not lose more than your initial deposit.
Article Source: Articlelogy.com
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