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Only eight years ago when investors in Australia wanted to borrow money they had few choices, either apply for a margin loan or borrow money from the bank to buy shares.

CFDs were introduced to Australia in 2003 and their introduction changed the industry forever. CFDs are the fastest growing derivative product in Australia, the growth rate over the last 7 years has been greater than the growth of any derivative product in history.

No longer does a retail investor need to apply for a bank loan or deal with expensive full service brokers. CFDs have revolutionized the financial services industry, retail investors can now open a CFD account online in minutes and be up and trading before the end of the day, executing all of their orders in real-time, online.

Unlike margin lending CFDs are typically traded over the internet with the trader’s portfolio being marked to market in real-time throughout the trading day, this is substantially different to the end of day portfolio revaluations used by traditional margin lenders. Real time portfolio margining means that traders can properly manage risk throughout the trading day rather than having to wait for statements to be generated at the end of the day.

When owning a CFDs like owning shares bought on a margin loan you will receive dividends, however it is important to note that as CFDs are simply derivative contracts you do not own the underlying share over which the CFD is based. Unlike owners of shares the holder of a CFD is not entitled to franking credits or voting rights. In most cases CFD traders are not concerned about franking credits or voting rights as they are short to medium term traders looking to profit from much smaller price changes than long term investors.

Unlike shares bought on a margin loan CFDs can be bought and sold with ease. Being able to short sell CFDs gives the CFD trader a significant advantage over the holder of a margin loan. Short selling allows traders the ability to profit when markets are in a down trend.

Buying shares on a margin loan tends to be much more expensive than buying CFDs. CFD providers will typically charge a commission rate of around 0.10 percent whereas a stockbroker will charge 0.50 percent. It is also important to consider financing rates, margin lenders charge financing in a very different way to CFD providers, in that the financing rate on a margin loan is calculated on the borrowed amount only whereas with CFDs it is calculated based on the full notional amount. It is common for CFD providers to charge a lower rate of interest than margin lenders. Most CFD traders are not concerned about the financing charge as their positions are usually held open for a relatively short period of time.

Typically CFDs offer traders more leverage than conventional margin loans allowing traders to obtain a better return on their investment. Traders should also be aware that an increase in leverage can also result in an increase in risk, this is common with all leveraged products. The leverage offered for CFD trading can be as much as 100 times whereas margin lenders will generally only offer around 10 times leverage or less. Leverage varies between each CFD provider and margin lender and is often determined on a stock by stock basis considering the market capitalisation of the stock and liquidity.

CFDs cannot be transferred from one provider to another this is simply because CFDs are over-the-counter derivatives and can only be closed with the CFD provider the position was opened with. As margin loans entail the purchase of the actual shares the holder of the margin loan is fee to transfer their share portfolio from one broker to another.

CFDs and margin loans suit different types of traders. CFDs are suited to more frequent short term traders wanting low commissions and the ability to trade both directions of the market. On the other hand margin loans are better suited to long term stock holders, simply because of the franking credits that can be obtained. Both products have their benefits however it is important to remember that both a leveraged and when trading leveraged products you should have in place a proper risk management plan.

Want to find out more about CFDs, then visit Ben McGrath’s favourite site on how to learn more about CFD trading.

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