CFDs, which stands for Contracts for Difference, are one of the most innovative and interesting tools for those who want to play the stock market and trade online.
They are a relative novelty in the financial world, which has opened the doors of the most interesting markets to those who, until a few years ago, were forced to invest with more expensive and less performing instruments.
In today’s guide, we will look at CFDs, analyse their functioning and potential, the benefits they offer to non-institutional investors and decide together whether or not to create a portfolio that favours CFDs for investment.
All the best brokers of the moment use this new form of trading, which with brokers like eToro you can also test in demos here.
But that’s not all! In addition to the above mentioned eToro, there are many other platforms that allow you to play CFDs on the stock exchange in a safe and professional way. What are they? Take a look at the table below.
What are CFDs?
CFDs are financial contracts between two parties, in the case of our investment between us and the broker we have chosen, which have the market value of another security.
We are not a fan of school definitions here at GiocareInBorsa.net and that is why we will proceed with an example that will help us understand how they work.
Let’s take the example of a CFD on ENI shares. The contract in question has a value of 14.25 pounds, which is the current market price of ENI shares in Piazza Affari. In all respects it therefore replicates the performance of the ENI share, which is said in this case below.
As far as the parties involved are concerned, however, it is the broker who issues the CFD contract and it is we who buy it.
At this point, in the beginning, you may already be wondering why you should buy CFDs instead of shares, since they have the same value and follow the same trend. To get a complete answer to this question, however, you will need to continue reading our guide.
To begin with, we can tell you that with CFDs you do not own the underlying asset, but you are only interested in its value, which opens up many possibilities that direct securities cannot guarantee.
The secret to the success of CFDs
The secret to the success of CFDs compared to direct securities is all here: you are not buying a financial security, but a contract whose value is that of the performance of the underlying security.
The operation of these products may not be intuitive, which is why we will continue with our analysis.
The first advantage: with CFDs you can invest on the margin, without buying the security directly.
If you wanted to buy 100 Apple shares, which are worth around £165 when we write you, you would have to pay 100 x 165 = £16,500.
Not a bad amount to have a small amount of shares.
In the old financial world, however, you couldn’t do otherwise, and you had to bend to market prices, put the shares in your portfolio and one day, hopefully, sell them at higher prices.
But CFDs work differently. Since you don’t have to buy the underlying security, but are actually playing on the stock exchange with a contract that follows the same price, trading platforms allow you to pay only part of the amount that would cost the shares, which they actually need to cover the price variation margin of the underlying security.
NOTE: The best way to understand how margin trading works is to see it applied. Today you can also do this with a free demo of IQ Option (find out more here).
Difficult to understand? Don’t worry, there’s nothing wrong with your financial analysis skills and it’s more than normal to find yourself banned from these contracts, but we invite you to investigate further if you want to invest the best for your possibilities.
An example, also in this case, will help us a lot to solve the problem.
Let’s go back to our Apple shares. We would like 100 in our portfolio, for a value of 16,500 pounds, but we can’t afford it.
The CFD platform, allows us, with a margin of 1:10, to have 100 shares, but only 10% of the value, or £1,650.
Are you crazy? Are you giving us money? Not at all, even the broker’s sole objective is to maximise his profit, and he doesn’t lend money without guarantees.