12 Feb | A Guide To Online Shares Trading
With share markets booming once again online shares trading is back in vogue. But this time many people are choosing to use financial derivative such as CFDs and spread betting to trade shares. Below we will look at how these financial derivatives allow you to trade shares and how they compare to traditional share trading.
Using Financial Derivatives To Trade Shares
With traditional share trading you purchase shares and then sell them for a profit when they increase in price. In comparison, with CFDs and spread bets the value derives from the underlying share. You do not actually purchase this share itself.
For example, imagine you are using traditional trading and you buy shares in IBM. When you want to purchase the IBM shares you would place an order with your stockbroker either online or over the telephone.
With a financial derivative such as CFDs or spread betting you are not actually purchasing the IBM shares. Instead you’re purchasing a derivative which is based on the IBM shares. You can choose to go either long (predict a rise in price) or go short (predict a fall in price) on the shares.
If you correctly predict the movement of the share then you can make money. If you predict incorrectly then you will make a loss.
The Benefits Of Financial Derivative Trading Compared To Traditional Share Trading
Whether you choose to use CFDs or spread betting there are a number of benefits to financial derivative share trading over than traditional share trading. Here are some of the key advantages of using derivative share trading.
Leverage – With traditional share trading you can open up a margin account. But, the amount that you can trade on margin is usually fairly limited. A standard amount of margin would be 50%. This means that if you put up £1000 in deposit you could have potential trading exposure of £2000.
In comparison with CFDs and spread betting the deposit requirements are as little as 1% to 10%. So, with a 5% deposit requirement, if you put up the same £1000 you could have a potential exposure of £20,000.
There are no commissions – With traditional online shares trading you are charged a commission every time you buy or sell shares. For frequent traders this can be a significant expense.
In contrast, with derivative trades you are not charged a commission. Instead the CFD or spread betting firm makes them money from the spread. The spread is the difference between the buy price and the sell price. When spreads are tight (a smaller difference between the buy and the sell price) this can make financial derivative trading less expensive for frequent traders.
Make money in both directions – Another attractive feature of CFD and spread betting is the ability to make money no matter which direction shares move.
With traditional online shares trading you generally can only make money if the shares increase in value from the point at which you bought them.
In contrast, CFD and spread betting offer a wide range of shares that you can go both long and short on. This provides you the flexibility to make money – or a loss –whether you think that shares are overvalued or undervalued.
Financial derivatives have become very popular way to trade shares. They provide flexibility to benefit from rising or falling share prices.
They also require significantly less capital required to get started. To make money with financial derivatives you need to understand the fundamentals of trading and have a trading strategy plan that works.