CFD trading has grown dramatically over the past decade, with investors being attracted by the potential for big gains which exist with this type of trading.
If you have a portfolio yourself but have not yet ventured into CFD trading, then you may be wondering how CFD trading differs to trading in stocks directly?
Here we’ll explain a few of the key differences, to give you a bit of an understanding of how the CFD market works.
Trading in Units
When you buy a share on the stock market, you actually take ownership of that share. The share therefore belongs to you. When you trade CFDs, you don’t actually take ownership of any asset when you make the trade.
Instead you trade in units, the price of which is linked to the underlying asset, market or commodity that you are trading. Your profits will then be determined by the rising or falling price of the unit, rather than the share itself – though unit prices will usually closely mirror a rise and fall in the underlying asset.
If the concept of this still sounds confusing to you then you can get a more detailed explanation of how the process works on the page related to CFD trading at CMC Markets.
This page explains exactly how trading in units works and also gives more information on how to make a success of CFD trading.
Trading on a Margin
Another reason for the drastic rise in volume of CFD trading over the past 10 years is the fact that traders are able to trade on a margin. Trading on a margin or with leverage allows traders to place much bigger trades than they would normally be able to.
This is because traders are only asked to put down a small amount of the size of the overall trade, perhaps around 5% of the trade. This means that you could effectively place a trade of £100 with just £5 of capital.
Trading this way has the potential to increase your gains, but it could also increase your losses and could lead to you losing more than your initial investment amount.
Another big difference between trading CFDs and trading directly on the stock market is the tax treatment of trades, particularly with UK stamp duty.
When you buy a share on the stock market, you actually purchase the asset and therefore the government levies a stamp duty charge on the trade.
When trading in CFDs, you are only trading in units. This means that you never actually take ownership of the share and therefore no stamp duty is due.
A Growing Market
So, there we have 3 simple ways in which trading in CFDs differs from trading on stock markets directly. There are many other differences too, and when all of these have been taken into consideration, it is easy to see why the volume of trading in the CFD market has grown so dramatically over the past 10 years and will likely continue to grow for some time to come.