Trading on the internet in Contracts For Difference has become increasingly popular in many countries such as the Australia, United Kingdom, Ireland and Singapore (although not in the United States as they are not allowed). More importantly, many investors now prefer CFD trading to dealing in conventional stocks. There are 3 main reasons for this:
First, CFDs only require the investor to pay a small margin payment instead of the full value of the investment. To understand this, consider an investment in ABCXYZ Corp of 300 shares. If the current stock price is $ 1 then, the traditional stock investor would have to stump up $ 300 to establish his or her position. The CFD trader on the other hand will only have to pay the margin required which could be as low as, say, 10% for example. In other words, they would pay only $ 30 for their investment.
This kind of margin benefit is clearly very attractive for many people but it also carries a risk that you need to be aware of. If the price of the stock drops then the investor can end up owed more than the original amount that they invested. If this happens the stockbroker will make a "margin call" requesting more money. If you can not pay then you are in trouble!
Second, contracts for difference allow investors to take "short" positions in stocks. This means that you can benefit and make money from falling prices. Instead of buying at $ 70 and selling at $ 100 to get yourself a $ 30 profit per share, a short position works the opposite way around. You would sell short the stock at, say, $ 100 and, if things go well, then the stock price will fall to $ 70. Then you can buy back to lock-in your $ 30 profit.
If you are new to this then it is a good idea to read the above explanation again until you understand. Shorting stocks can be a tricky thing to get your head around to start with. But it's really not that difficult when you get used to it. Just like with margin payments, you need to be careful and know what you are doing with shorting. This is because, at least in theory, you can lose an unlimited amount of money! To see why this is the case, imagine what would happen if the stock price of a company that you shorted doubled, or tripled. You would be forced to buy back the stock at a much higher price which would lose you lots of money. Because there is no upper limit to the share price, your losses can also be unlimited.
The third reason why CFDs are better than regular stock investing has to do with tax advantages. This only applies in some countries and also varies from country to country. Currently, tax benefits are available in the UK and Ireland for example. In these countries you do not have to pay the tax on buying shares when you use CFDs like you would normally have to do with traditional stock investing.