Share CFDs are contracts that enable you to trade on the changes in price of shares, without owning the underlying shares. And, as you aren’t purchasing the shares concerned, you can open a position with a deposit from just 5% of their value.
This means you can make large profits relative to your initial investment.
For instance, if you purchased 5,000 AMP shares at $4.10, you would need to outlay the whole value of the 5,000 shares, $20,500 in this situation. By contrast, trading share CFDs allows you to enter a position on the same 5,000 shares with a deposit from just 5% of the total value, or $1,025 ($20,500 x 5%).
If the AMP shares climbed to $4.35, the value of your position would be $21,750, regardless of whether you were trading traditional shares or share CFDs. But the difference is when you look at this return relative to your original investment. $1,250 is a 6% return on your share investment of $20,500. By contrast, it is a 122% return on your CFD investment of $1,025.
This gearing (or leverage) is one of the advantages of trading shares through CFDs, and it means that, if you had $20,500 to invest, you might either use you extra capital to open a bigger position, or you could use it to open more positions across a selection of markets.
That being said, gearing is also the greatest risk of trading CFDs, as it amplifies your losses to the same degree that it exaggerates your profits.
If the AMP share price had fallen to $3.95 instead of rising, you would have lost 15 cents per share, or $750 in total. In conventional share trading, this is only 4% of your original investment of $20,500. But in CFD trading, this $750 loss is 73% of your initial investment of $1,025.
Consequently, CFD providers offer a number of tools to control the risks of CFD trading, including stop-losses and limit orders*. A stop-loss is an automated closing level you set on your trade in the event the share price turns against you. In the prior example you might have set a stop-loss at $4.05 and the trade would have closed when the shares traded through that price, capping your losses at $0.05 a share.
A limit order works in a similar fashion, but are used to lock in profits instead of limit losses. You set an automated closing level if the share price move in your favor. Let’s assume the AMP shares went up to $4.30, and then dropped. You would have missed a potential $0.20 of profit per share. However, if you had placed a limit order at $4.25, the trade would have closed automatically at $4.25, securing you 15 cents a share in profit. Continue Reading »