Understanding Margin Lending

Margin lending implies providing traders with the ability of controlling bigger positions than the balance in their trading account. It is tantamount to lending money without collateral and traders have to pay some interest if positions are carried overnight. Margin lending is common tool in forex trading and CFD trading. Both systems are based on spread betting and owe their popularity to the leveraged trading, commonly known as margin lending. Leverages can be as big as in the ratio of 250:1 in the case of forex trading meaning that a trade of the value of 250 dollars can be placed with only one dollar in the account. In CFD trading, margins can be as low as 5%, meaning that a trader pays only 5% of the total value of the contract. There is no collateral involved but the system works extremely efficiently and advantageous to both the parties involved; the trader and the broker.

It is actually a risk free loan of sorts because the moment the market moves against the trader’s position and there is not enough balance in the account to cover losses, the system alerts the traders to deposit more money in the account. If the trader fails to do so, the system automatically closes the position.

It is true that margin lending allows traders to make money quick if the market moves favourable to the position taken by the trader. However, the opposite is also true. The reality is that it can also prove to be a one-way ticket to the poor house. It is thus important to understand margin lending in its true perspective and trade with caution.

Do Managed Funds Make Sense

To understand the meaning of managed funds, it is necessary to understand what is meant by active portfolio management.

Active management of a portfolio is an attempt to get better returns than would be otherwise possible by investing in an investment benchmark index. In simple language, manager of a managed fund subscribes to the theory that it is possible to outperform an index by rotating investments frequently; buying when the market is declining and selling when it is up. Index funds or passively managed funds, on the other hand, are based on the theory that it is next to impossible to outperform the benchmark market index.

There is also another aspect involved in the debate between managed funds and passive funds. Those in favour of active management profess that market inefficiencies can be exploited by buying undervalued and short selling overvalued securities. The other side of the story is that markets always discount information that is readily available and there is no way that returns more than the average market return can be achieved in the long run. Proponents of passive funds are of the opinion that active management actually lowers returns due to the involvement of commissions for churning portfolios.Managed funds should also be viewed in the backdrop of how active management in defined. Some managers would convert totally to cash or employ hedging techniques in a declining market while others will only make minor adjustments in the portfolio. The performance of a managed fund thus depends largely on the manager’s skills.

The point to be noted is that passive funds comprise of only 20% of all mutual funds. The balance 80% are managed funds having portfolios similar to various indices and rarely outperform the index they resemble.

CFD Tracker

CFD tracker refers to a special type of account with a CFD provider. A CFD tracker account enables the trader to minimise transaction cost by choosing the right level of leverage or financing.

Before we move to defining a CFD tracker account, it would be better to understand CFDs in detail. We all know that a CFD is a derivative product that may be based on a company’s stock, currency pair, commodity or index. It is a leveraged system of trading where a trader can place high-value trades with a very small capital outlay, sometimes with only 5% of the value of the contract. The balance is financed or loaned by the CFD provider.

Actually, this is one of the major reasons that CFDs have become extremely popular in Australia despite being a relatively new derivate product. However, what is not talked about much is the fact of interest charged on the balance amount if the trader carries a trade overnight. Howsoever small the interest rate may be, it does add to the cost. A CFD tracker is actually meant to restrict interest costs so that a winning does not turn into a losing trade.

CFD tracker allows investors to choose the level of borrowing and choose exactly how much financing they want in each trade, anything from 0 to 99%. This can be of great value to investors who normally have a long term time horizon while trading. Another advantage is that it allows traders to invest in a fraction (up to 1/1000th of a unit) of a share or a specific monetary value.

Stockbroker Is Different From a Provider Of CFDs In Stocks

Like it or not, you need a stockbroker of some sort to be able to buy or sell equities. Nevertheless, the dramatic change of scene brought about by the Internet has provided traders with a number of options in regard to the type of stockbroker they choose to deal with.

It is necessary to deal with a stockbroker because you cannot deal directly with the stock exchange. The stockbroker charges a commission on each trade for this service. Being an extremely competitive market, most brokers also offer certain value added services such as supplying account holders with market news and analysis, annual reports and buying and selling tips.

The Internet has enabled online trading, which has been instrumental in changing the face of financial markets and opening up the new markets for individual traders. For example, the foreign exchange (forex) market, which was at one time reserved for banks and large financial institutions, is now open to the small individual investors. In addition, it has also enabled the introduction of new products such as CFDs. CFD or contract for difference, is a tradable instrument whose price is based on the value of underlying assets including equities.

A CFD with a company’s stock as the underlying asset means that traders can benefit from price movement in stocks without having to deal with a broker. Both forex and CFDs are over-the-counter markets. Trades are directly between two principals without the necessity of routing transactions through a central agency like a stock exchange. This has prompted many stockbroking firms to take on the role of forex dealers and CFD providers. However, being an unregulated market, it is advisable that beginners check the difference between a stockbroker and CFD provider as scams in financial markets are not unknown.

CFD Providers

Both CFD broker and a stock broker do the same thing; allow you to trade in stocks. Then why is that CFD brokers are often called CFD providers but stock brokers are never called stock providers

The basic reason is that stock brokers are agents who communicate with the stock exchange on behalf of their clients. CFD providers are principals and counterparty to the trade initiated by you. When traders buy, CFD providers themselves are the sellers. Whereas, traders can buy on a stock exchanges only if there are sellers ready to sell in the market. If there are no sellers, you cannot buy in the stock market. It is another matter that if there are no sellers in the market for the underlying share of a CFD, CFD providers may not offer it to traders for buying unless they are ready to take the risk. This is because they have to hedge their bets in the stock exchange by placing counter trades; if they sell Rio Tinto CFD comprising of 100 shares, they have to buy 100 shares to manage their risk.

CFD providers are a part of a larger over-the-counter market and their activity is not limited to share CFDs. Apart from shares, a typical CFD provider would offer the ability to trade in forex, indices and commodities across global markets.

The CFD market is generally unregulated and it is incumbent on traders, especially beginners to be careful while choosing a CFD provider. Try not to believe those who indulge in aggressive marketing, make unrealistic claims that look too good to be true.

Difference between a Stock Broker and CFD Broker

CFD broker is actually a misnomer because technically he is a principal and not an agent. The reason for this is that in the CFD market trades are placed directly between a dealer, commonly known as a CFD broker and a trader. However, in certain cases there may be a broker acting on behalf of a CFD provider.

Regardless of whether we call him a broker or dealer, the job profile is the same as a traditional broker. The difference is that stock broker is an agent who acts as a go-between you and the stock exchange and earns through the commission he charges on each trade. A CFD broker, on the other hand, does not charge a commission but earns his profit from spreads. A spread is the difference between the rate at which he sells a CFD and the rate at which he buys.

A stock broker does not carry any risk. He will allow trades only of as much value as there is money in the trading account of a client. A CFD broker, on the other hand, is counterparty in the contract and must cover his risk by placing counter trades in the market pertaining to the underlying asset. For example, if you buy a Telstra CFD worth 100 shares, the CFD provider will sell 100 Telstra shares in the stock market at the current prevailing price to hedge his risk.

A CFD broker provides traders with the ability to open, close and manage market positions through a web-based trading platform. A stock broker may however do the same through proprietary software made available for download to a client’s computer.

Pluses and Minuses of Trading in CFDs

CFDs are a relatively new product in the Australian markets. Trading in CFDs has many advantages such as lower margin requirements, simple pricing, easy access to global markets, the ability to short sell, absence of day trading rules and little or no commissions and transaction fees. Actually, CFD is the latest blue eyed boy of the market.

CFD refers to contract for difference, a tradable product where settlements are done on the basis of difference between the closing and opening values of the trade. It relates to an underlying asset and the only thing that matters is the price difference. This means that prior ownership is not necessary and traders can profit by short selling if they are bearish on the underlying asset.

However, despite so many advantages, each trader must weigh the pluses and minuses of CFD trading and proceed accordingly. There are certain disadvantages of CFD trading that have to be taken into account before settling on any trading plan.

CFDs are traded on spreads, the difference between the price at which providers of CFDs sell and buy a CFD. Having to pay the spread on entry and exit means that traders cannot benefit from small move. The spread reduces the profit from winning trades and increases the loss in losing trades by a small amount. If there are commissions and fees and regulations in stock markets, providers of CFDs have their way of cutting down profits of traders with larger spreads.

Another minus point of trading in CFDs is that the CFD market is not as regulated as the stock market is. While there are many reputable CFD providers, being an over-the-counter market, traders still need to be careful while selecting whom to trade with.

CFD and Stock Options

Apart from trading directly in equities, traders have the option of participating in another way as well; they can trade in derivatives instead. Option trading is one of the popular derivatives and has been quite popular with experienced traders. While options have been there since long, many beginners are not familiar with CFD, a derivative product that is relatively new to the Australian markets.

A CFD or contract for difference provides an option to traders to trade in stocks or any other financial instrument in the market without ownership. For example, you can trade a Telstra CFD without having to buy its shares.

Contract for difference is an agreement for paying or receiving the difference between the closing price of the underlying asset and the price at the time the contract was entered into. Every CFD has an underlying asset. It could be a share, commodity, currency pair or an index.

Many investors often ask how it is different from trading options. The primary difference and also the reason why it is preferred over option trading is the simplicity of its pricing. The primary feature of option trading is the time premium attached to it. The premium decays as it nears the expiry date. A contract for difference reflects only the price of the underlying stock; there is no time value attached and no premium to decay. Moreover, CFDs are available for a wide range of underlying assets.

However, the element of risk is the same as in stock and forex trading. Since it employs a high level of leverage, the risk of losing money is as great as the increased potential for profit should the markets move adversely. It is thus recommended that investors be careful while trading in CFDs.