Before reading this lesson, you should have read through:

Now that you have an understanding of what stocks and shares are, you may ask the question: how do you actually trade shares?

If you would like to buy and hold shares, then usually you can go to a normal bank and buy shares. If you want to be more active as a trader, buying and selling in a short-term period, then using an online broker would be more suitable.

The answer to this question usually depends on how active you want to be as an investor or a trader. Those that want to buy and hold shares for many years can go to a bank, who usually have the means to buy shares. The fees that a traditional bank charge – you are usually charged twice, once to buy and again to sell – are high. The rise in value of those shares over the long term will generally more than compensate for the fees you have to pay.

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You can use an online broker to trade more frequently

However, if you want to buy and sell shares quickly, to take advantage of short term price movements, then this method, due to the high cost of trading, will not suit you.

To be more active in the markets, it would be best to trade through an online broker.

It's a fairly straightforward process where you place an order with a broker using a piece of software called a trading platform, and it will execute buy and sell orders on your behalf.

Start trading with EXANTE, and we will guide you through your first trade!


There are two different ways of trading shares

The way you can trade shares has altered in recent years. It used to be the case that in order to buy a share, you would take ownership over the actual share and have that ownership until you sold that share again.

There is now another way in which you can trade shares and this is by using what is called a contract for difference.

A contract for difference, or CFD, allows you to take advantage of the same price movements, but you do not take ownership of the shares at any point.

A CFD is an agreement between a buyer and a seller

A CFD is an agreement between two parties, one of which is a buyer and the other a seller – one party is usually the broker or a CFD provider.

What is a CFD? A CFD is an agreement between a buyer and a seller on the price movement of a share. If the price of a share goes up, then the seller pays the difference in price to the buyer. If the price goes down, then the buyer pays the seller the difference in price.

If a person buys a CFD of a share and the price of that share is higher when the trade is closed, the buyer will receive the difference in the price from the seller.

If the price of the share is lower at the time the trade is closed, the buyer has to give the seller the difference in price.

The agreement is based on the price movement only. So if you buy a CFD of a share, the actual transfer of the share does not take place.

Want to be safe? Trade real stocks with EXANTE! No CFDs and hidden commissions


The price of the CFD is based on the underlying share

The underlying share is the actual share that the CFD is based on – remember you are not actually taking ownership and therefore trading the share.

When you trade a CFD of a share, the price of the CFD and the share will be the same – they do not trade any differently.

Using leverage

Using leverage means that you essentially borrow money from the broker in order to trade more shares than you usually would with your account.

An advantage to trading with CFDs is that you can use leverage.

When conventionally buying shares, you would have to have the amount that you wished to purchase in your account. For example, if a company had shares worth $10 and you wished to purchase 1000 for them, then you would have $10,000 in your account in order to do so.

If the shares then went up by $0.1 per share, then the shares are now worth $10,100 and you have made $100 in profit.

However, you may not have $10,000 in your account to do so.

Using leverage means that you essentially borrow money from the broker in order to trade more shares than you usually would with your account.

Taking the same example, if you only have $1000 in your account and you still wished to purchase 1000 shares, the broker would effectively lend you $9000 and you purchase the shares with the combined amount of $10,000. This means that if the shares went up by $0.1, then you have still made $100 on this trade.

When you sell the CFDs again, then the money that was financed by the broker is returned and you are left with $1100 in your account.

This is usually known as either a leverage amount of 10:1 or a margin of 10% – you need 10% of the total value to make the trade.

This allows you to gain a higher return on your initial investment than if you traded shares in the conventional method.

Danger using leverage

You must also note, however, that you can also lose just as much as if you had a larger account size. To take the example above, if the share went down by $0.1, then you would have lost $100 and your total capital would have then gone down to $900 – you would have lost 10% of your account.

In order to ensure that a few losing trades do not wipe out your account, you should only ever risk a maximum of 2% of your total trading capital on any single trade.

To learn more about money management, go to the following subject:

Subject
Learn how to use important tools like risk-to-reward ratios and stop losses to maximise your profits and minimise losses.

Costs of trading

For any trade, whether you are trading shares in the conventional way or are trading with CFDs, you need to pay your broker or provider a fee when you open and close your position.

Spreads and commission

When making trades, there will be a cost involved in either the form of a spread or a commission. There is also likely to be an overnight financing fee if you hold your position overnight. In the cases of a short position, you can be credited the financing fee.

Most CFD brokers will charge a spread or a commission of each side of the trade. That means that there will be a charge for both opening and closing the position.

Overnight financing fees

When trading with CFDs, you are liable to pay a financing fee for any long position that you hold overnight. This is usually based on the interbank or LIBOR lending rate, but in some cases it can simply be set by the broker.

If you are short, you are usually credited the lending rate fee, unless the lending rate is extremely low.

CFDs pay dividends

When trading CFDs of shares, you are entitled to dividend payments, as long as you hold the CFD the day before the ex-dividend date, that is the day before which you must own the stock/CFD so that you qualify for receiving the payment. You can find the date on the investor relations webpage of the company whose stock you trade.

The ex-dividend date is the day before which you must own the stock/CFD to qualify for dividend payment. You can find the date on the investor relations webpage of the company whose stock you trade.

To receive a dividend payment, you must hold a long position. You will receive a payment of whatever the dividend is for that company for every share you have. For example, if you owned shares in a company that pays a quarterly dividend of $0.10 per share, you would be credited $0.10 for every share you held.

The payment date is the date the dividend is actually paid.

The process of receiving payments for dividends is usually more straight forward than owning the actual share. When owning a share, the dividend payment may be a few weeks after the ex-dividend date, whereas you usually receive payment the next working day for a CFD.

You are liable for the dividend payment for short positions

If you hold a long position you can be entitled to dividend payments if you own the CFD the day before the ex-dividend date. If you hold a short position then you are liable for the dividend payment.

You should be aware that holding a short position will make you liable for the dividend payment. If you short sell a CFD of a company's share that pays a dividend, you would be charged the dividend payment for each share that you own.

Even though you are entitled to dividends, you do not have all the same rights as an actual owner. For example, someone who owns shares in a company may be entitled to go to shareholder meetings or have voting rights – owning a CFD does not entitle you to this.

Trading shares vs CFDs

Whether you decide to trade using CFDs or trading the underlying share is down to the preference of the trader – both have advantages. For example, if you would like to hold a position for a significant period of time, then you may wish to buy the actual shares instead of trading with a CFD, because there are no financing costs involved.

It is easier to be able to short sell CFDs than holding the actual shares, because the agreement is usually between you and the broker. When shorting actual shares, an entity would have to lend you the shares to be sold in order to buy them back at a lower price.

Regulation also, from time-to-time, prohibits the short selling of shares, depending on the regulator. Sort selling on CFDs very rarely comes under such restriction.

However, when using CFDs you are able to take advantage of increased return on investment because you can make use of leverage.

Summary

In this lesson you have learned that...

  • ... a contract for difference is a agreement between two parties based on the price movement of a share – one party will pay the other party the difference in price.
  • ... a CFD is based on an underlying asset. The price movements are the same.
  • ... there are costs to CFD trading in the form of spreads and commissions.
  • ... if you buy a CFD and hold it overnight, you will usually be charged a overnight financing fee based on the overnight interest rate. If you short sell a CFD then you will usually be credited an overnight interest rate.
  • ... an advantage to trading a CFD is the use of leverage – trading the a higher volume of shares as if you had a larger trading capital.
  • ... CFDs entitle you to dividend payments, but will not entitle you to attend share holders meetings or voting rights.
  • ... if you are holding a short position, then you will actually be charged the dividend rate.
  • ... there are other advantages to trading with CFDs, such as easier access to trade many different shares, speed of execution and they are generally cheaper.
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  • "never risk 2% of your total trading capital" could be a good rule for choosing stop loss limits, i guess..? (after to have chosen the leverage and the total import of investment, i mean)
    that "2%" is comprehensive of fee/commissions, or only "the gap we could accept to loose" about the price*leverage? (sorry for my glossary, i'm a beginner smile )
  • Hey mushyliver,

    Yes 2% is a great rule, no matter what you trade and you make a very good point about leverage that even after leverage, you only risk 2% of your total account - including the spread and the commission fees.

    Its great that you ask questions because this is the best way to learn. smile
  • so i think i'll produce an excel file for calculating the max ammount of every operations, in function of fee, maybe that gives me the stop loss price to insert when confirm (fake) operations on metatrade!
    (thinking about this file..already the first doubt XD..i was writing here..then diecided this page was more suitable, if you were curious to read wink)
  • I'll be delighted to read that smile
  • interesting leverage , it sounds good ,but as far as I know ,few people could make money from it ,right? I need time to absorb the knowledge
  • can I set a profit limit, I am trying to say can I sell if the price of my reaches a 4% increase?
  • Hey,

    It depends on the platform, but if the platform does not offer the function of setting a profit target based on a percentage of your account, then you can work out what a 4% increase would be based on the price it would reach (and the volume that you are trading) - or 4% increase on your position - and then you can set the profit target at that price.
  • I have one simple question.

    If I have 10000£ starting balance and I'm about to enter 3 trades, how this rule of 2% actually works?
    It is like a pie, 200£ for each trade no matter what?

    Or is more like 200£ for the 1st trade, then 2% of the 9800£(10000£-200£) for the 2nd trade, then another 2% of the 9604(9800-196)£ for the 3rd trade and we Would finish with a balance of 9411,92£ after the 3 trades entered?

    All the best
    Behebouser
  • It depends on what you are trading. If you are opening up 3 trades on the same asset, then you need to make sure that all three trades together are a maximum of 2%. This also goes for assets that correlate with each other.

    However, if you are opening up three separate trades at once and the assets do not correlate, then - in other words they really are thee completely separate trades, then you can look to use 2% on each trade.

    However, what I would recommend in the beginning is that you actually scale down your trades, either by risking 1% on each trade or by risking 2% on the first one, adjust your account by the risk and then risk 2% of that account size and so on.

    For example:

    Trade 1: £10,000 balance and risk =£200
    Trade 2: £9800 balance and risk = £196
    Trade 3: £9604 balance and risk = £192

    But that is just an example. In the beginning I would really look to trade only 0.5% -1% risk on each trade until you get used to it and you know that you can keep your account size stable.

    If you want some more information on correlation, then you can see the following lessons; they are at bronze (i.e. you have taken one live trade with of our brokers):

    Market correlation
    Currency correlation

    Or you can also check out the tradipedia entry:

    Currency correlation - tradipedia entry
  • Hi guys! I'm having problem playing the videos. I'm using Chrome on Windows 7 (64 bit). Anyone can help? Thanks!
  • Seems to be fine on my Windows Chrome. Have you tried it in any other browser?
  • Hi Dean! Yes I did. Tried IE, FF and Chrome. Also tried using Iphone, Win 8 tablet and Mac but still can't play any video. Really weird.
  • Hey can you send me an email @

    dean.peters-wright@tradimo.com

    Please tell me as many details as possible about your pc, broswer and what else you have tried it on and I'l see if I can get IT to help.

    Really sorry about this.
  • Hi Dean! I finally was able to watch the video. The issue is, for some reason, all the video seems to be blocked and unwatchable from my country Singapore. What I did is use ultrasurf in order to use a proxy, then I was able to watch the video.
  • Its great that you ask questions because this is the best way to learn.
  • One good thing about never risking more than 2% of your bankroll is that your bankroll is increasing constantly. This means that you are always playing at somewhat higher stakes.

    With Poker, you have to play at a certain limit for a period of time before moving up to higher stakes because you need to increase your bankroll to afford those higher stakes.
  • Slowly learning English is not good
  • Hi,
    Is that any online broker provides service to buy shares instead of CFDs?
    It will be great if we can buy shares online instead have to go to a normal bank and buy shares. Why online broker don't provide the service to buy shares?
    Thanks.
  • Hi JHTAN,
    It is because of the unpopularity and the drawbacks shares have compared to CFDs for active retail traders. Unless you want to buy and hold and/or have huge capital you really want to deal CFDs . Trading them is more flexible (shorting always allowed), and less expensive (no stamp duty in certain countries) and you always benefit from dividends just like with real shares. Please have a look at our lesson and you will understand why CFDs are more popular than buying actual shares: http://en.tradimo.com/learn/stock-trading/how-to-buy-and-sell-shares/

    Regards.
    Peter

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