The big difference between buying CFDs and buying shares

Q. “I received a trade signal last week to buy Woolies… I am a new member with Global Macro Trader and wanted to know what the big difference is between buying 200 Woolies CFDs versus buying 200 Woolies shares and how does the money multiplier effect come into play?

The BIGGEST difference between buying shares versus buying CFDs is that when you buy CFDs, you will gain exposure to the full value of the shares but you don’t own the share and you only pay a margin to gain this exposure.

To explain this better, allow me to give you an example for buying both instruments – starting with shares…

NOTE: For simplicity purposes – I will leave out trading costs for this example.

Buying 200 Woolies Shares

Let’s say Woolies is trading at R60.00 per share. If you buy 200 shares, you’ll have to pay the full R12,000 (200 shares X R60) to own them.

The problem is that, you’ll have a lot of your capital tied up in this one stock which you can use for other profit opportunities. This is where CFDs come in.

Buying 200 Woolies CFDs

Your broker tells you that the gearing on a Woolies share is 10 times.

This simply means that whatever the share price is trading at, you’ll pay 1/10th of the price to be exposed to the full value of the share.

Note: If you buy 1 Woolies CFD with a share price at R60 – you’ll only pay R6 per CFD (R60 per share ÷ 10 times gearing). This is called the initial margin (deposit) per CFD.

And if you buy 200 Woolies CFDs at R60 per share, you’ll only have to pay R1,200[(200 Shares X R60 per share) ÷ 10 times].

Instead of paying the full R12,000 to own 200 Woolies shares, you’ll just need to deposit R1,200 to be exposed to the full value of the 200 shares.

Now let’s get to the exciting part – the money multiplier effect of trading CFDs.

I’ll use our recent Global Macro trade on Firstrand. This JSE bluechip’s share price moved just 8% in 14 days but we were able to bank 84.28% in the same period – thanks to CFDs.

Here were the Global Macro trade specifics:

Firstrand was trading at R65.60 with a 9% gearing.

The share price moved to R70.70 after 14 days, If you’d bought 200 shares in Firstrand you would have had to put down R13,100 and made an 8% return – R1,040

If you’d bought 200 CFDs in Firstrand. you would only have put down R1,234 and made R1,040! An amazing 84.28% return thanks to the power of gearing.