What are some of the advantages – and risks – of trading CFDs instead of shares?

Unlike traditional shares, CFDs are traded on leverage. Leverage lets you trade the markets using a small fraction of the total trade value. For a smaller initial investment you can take the opportunity to profit from market movements and diversify your trading strategy and portfolio. Potential gains can be magnified, as you only deposit a small fraction of the total trade value, but access full market exposure.

As with all financial trading, there is the potential to lose all or part of your investment. The key risk with leverage is that it can magnify your losses in exactly the same way as your gains. City Index offers a range of risk management tools to help mitigate your risk.

CFD Trading Leverage Example: Woolworths

In conventional dealing, you would have to pay your broker the total value of the shares you wish to purchase plus any commissions that may be applicable i.e. 0.1% in some cases. Say you wish to purchase 10,000 Woolworths shares and the current share value is $25. You would have to pay the total value of the shares purchased, i.e. $250,000 (10,000 x $25) plus $250 commission.

With CFD trading however, you only need to deposit a small percentage of the total trade value for the same level of market exposure. We require a margin deposit of 5% of the total value of the Woolworths trade, i.e. an initial $12,500 (10,000 x $25 x 5%) plus commission (0.08%) to access the same $250,000 exposure to the underlying market.

Typical share CFD margins range from 5% to 25% on the most popular shares, with margins for indices such as Australia 200 and Wall Street starting at just 0.5%. Margins for major currency pairs start from just 0.5% and for commodity CFDs from 3%.

Ability to go long or short

The flexibility of CFDs lets you take advantage of the markets whether they are rising or falling. CFDs let you go long (buy) if you believe market prices will rise, or go short (sell) if you think prices will fall – so if you believe that a company or market will experience a loss in value in the short term, you can use CFDs to sell it today, and your profits will rise in line with any fall in that price – an opportunity not available with physical shares (however, if the market moves against you, your losses will also increase). Furthermore, depending on the instrument and current interest rate, you may be paid financing fees on positions held overnight.

Guaranteed stop losses are available at most CFD providers. These are a key tool in mitigating the risk of substantial losses.