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CFDs typically have lower trading fees than shares and options.
Commission charges usually range from 0.1% to 0.25% of the CFD value amount (not your initial investment) when you buy or sell CFDs. Sometimes, this is subjected to a minimum amount. Also, this does mean that you will be charged twice for a simple buy-and-sell transaction; once when you buy and once when you sell.
For some brokers, they may not even charge commission fees, and the only extra amount you’re paying will be the bid-ask spread! Note that the bid-ask spread is internally formed by the brokerage and is one of the main ways they profit from your trades.
Bid-Ask Spread
When it comes to any type of financial instrument, you may be presented with two different prices. This is unlike going to a currency exchange! One is the bid price, and one is the ask price. The bid price is the price at which you sell the financial asset to the broker, while the ask price is when you buy the broker's financial asset. The bid price is typically lower than the ask price, which is how the brokerages profit!
The difference between the bid price and the ask price is known as the bid-ask spread, and you can think of this as the price the brokerage is charging you per financial asset. The bid-ask spread will vary from brokerage to brokerage, so keep this in mind because it is still a type of fee that you should compare!
In the context of CFDs, you will buy CFDs at the ask price and close your position at the bid price.
There may also be holding costs applied if you choose to hold your CFDs after the daily market closures. Other charges may also be applied, but this differs from brokerage to brokerage, so it’s best to check with your broker.
CFDs are generally opened using leverage, hence you only need to pay a fraction of the position value upfront. You will borrow the rest from the brokerage. Hence, leverage will amplify your gains on the initial amount due to having a much larger position opened for you. Be warned, though, that this also heightens your losses!
If you’re expecting the price of a share to plummet, shorting CFDs is one of the various ways to profit from the fall of a share price. Using derivatives such as options and CFDs are a good way to take an indirect short position in shares.
Like any other financial derivatives, you can use CFDs to hedge your portfolios against possible losses. This can be a complicated process, so seek out professional advice if needed!
With higher returns come higher risks. While trading on margin magnifies your earnings, it also magnifies your losses if the market swings the other way. You may lose your entire original investment and more!
Let’s look at a more realistic scenario where you invest in the thousands. If your initial investment amount in CapitaLand CFDs is $10,000 and the leverage is 20:1, your position will open with an investment of $200,000 ($190,000 borrowed). The moment the CapitaLand Shares drop from $4 to $3.80, which is a 5% decrease, your entire initial investment will be wiped out!
Like options, CFDs are not available for every share, bond, or index you come across.
CFDs are usually not traded on exchanges; they’re traded over-the-counter (OTC) with your brokerages. This means that the other party is actually your CFD broker, who could fail to fulfil their end of the contract (e.g. if you close your CFD position but your brokerage fails to pay you the difference that’s due). This inability to fulfil their financial obligation will void the value of your CFD. Hence, you must choose an appropriate brokerage with a strong financial standing and stellar reputation.
Note that you cannot transfer your CFD over to another CFD brokerage! They are contracts between you and the brokerage you bought it from.
As mentioned, there are two different prices: the bid and the ask. On exchanges, the bid and ask price are settled through demand and supply, i.e. the transactions taking place on the exchange. However, because over-the-counter transactions operate in a closed system, the brokerage firm decides the bid and ask prices for their CFDs, with reference to the market price of the underlying assets. As such, there may be a difference.
Typically, brokerage firms will try to remain competitive and follow the market price as closely as possible. Still, when the market faces high volatility and prices constantly fluctuate, the bid-ask spread may widen and deviate from the market prices. As we know, the bid-ask spread acts as a brokerage fee, so a widening spread is not favourable to investors.
DLCs may be a way to mitigate the two risks shown above that stem from over-the-counter transactions. So what are DLCs?
Sounds familiar? You can think of DLCs as the exchange-traded versions of CFDs! As they are traded on the exchange, it reduces counterparty risks and price transparency. However, trading on exchanges has its drawbacks: products are all standardised, so there will be no room for customisation, fixed trading hours, and your product range may be limited to what’s already available.
In Singapore, you have ready access to both CFDs and DLCs, so decide which of the two is more suited for your investment objectives.
CFD BENEFITS. COMPLETED. ✅
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