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Trading CFD VS stocks in Singapore – how do they compare?
Contracts for Difference (CFD) are financial derivative products representing the difference between where a trade on an underlying asset is entered and where it is exited. The underlying asset on a CFD is more commonly a stock, but it can also be an index, bond, currency or commodity.
Source: Nexsus Financial Markets
Profits or losses are realised on the CFD when the underlying asset moves in relation to the position taken. CFDs are traded on margin, a minimum amount of margin must be retained at all times, and they do not expire until closed out.
One of the chief differences between a share and a CFD is that there is no ownership claim (and no dividend) with a CFD. It is in effect a contract between the client and the broker. CFDs require less money upfront than buying shares, because the contracts are purchased using margin. Shares can be purchased on margin, but a greater margin amount will normally be required for shares and opening such an account in Singapore is not always straightforward.
The advantage of paying a lower margin is obvious. But the CFD trader can be closed out if his position moves against him and he is not holding sufficient margin in his account. CFD are leveraged financial products. This means that not only are profits magnified, but losses can be much higher compared to unleveraged investments.
Let us take a quick look at an example of a CFD on a Singapore stock
Share Price of company X = $5.50 per share
10 lots of stocks = $5.50 x 1000 = $5,550
The lot size of a CFD will depend on the underlying asset, and so for this example, if you bought 1000 shares at a margin rate of 10%, you would need to pay:
$5.50 x 1000 x 10% = $550
In this case, a mere 10% of the share price allows you to trade a CFD that gives you exposure to 1,000 shares. A CFD can be a more efficient use of your capital, although of course you want to get the bet right!
When it comes to short selling, there are further notable differences between CFD and shares. It is much easier to short-sell CFDs in contrast to stocks. Many brokerages in Singapore only allow investors to buy stocks, which reduces strategies for those wanting to take a bearish view. With CFD trading, selling is no more complex than buying, making it a great way to take advantage of falling prices, or a down trend in a particular stock or sector.
In addition, CFD trading can be used as a hedge when you have bought the underlying shares, but are concerned about a short term fall in the price. You can short the CFD while you continue to hold the shares.
Financial health warnings for CFDs
Leverage – Leverage should be treated with great care and caution. While it allows you to gain more exposure to a particular financial instrument with less funds, and it magnifies your gains, it also does the same to your losses.
Source: ForTrader.org
Because CFDs are leveraged instruments, you are required to hold sufficient deposit or margin in your trading account. And if the market moves against you, you might receive a margin call to top up your funds. If you fail to keep enough margin in your account, your broker may close out your position without notice.
Less transparency – CFD trading in Singapore is normally transacted “over-the-counter” (OTC), in other words privately negotiated with the broker. As a consequence, CFD trading will automatically be less transparent compared to trading listed shares on an organised exchange.
Source: Kurtosys
In fact, depending on the broker, the broker may act as your counterparty as well as executing the trade. This means your broker will aim to profit from your losses.
No shareholder privileges – As mentioned above, you do not own the underlying shares when you trade CFD, and thus you will not be entitled to voting rights or to receive any other shareholder benefits.
Source: Tertiary Minerals plc
While you do receive dividends on long positions (subject to a dividend adjustment), an amount will actually be debited if you are holding short positions at the close of business on the day the underlying goes ex-dividend.
Only highly sophisticated investors should even consider CFD. While the same is often said about stocks, the potential for substantial losses on CFD is considerably higher. If you still feel game to try CFD after the health warnings, good luck!
(By Lynette Tan)
