Margin vs. CFD Trading

Many people are confused with the difference between Margin trading and Contract for Difference, while there are similarities between the two there are several important differences between the two instruments. 

Both forms of trading use Margin. When you open a Margin FX or Stock position you only have to put up a small percentage of the cash up front effectively borrowing the rest of the money for the position from the broker. You may be able to open a $5,000 position with only $500 in your trading account for instance. The same thing happens when you open a position with a Contract for difference provider with the trader being able to open a position worth a $5,000 with only $50 in their account. The difference is when you open a Contract for Difference position you do not actually own the underlying financial instrument in question, you are entering into a Contract with a counter party namely your brokerage. Where as with Margin Trading you are the owner of the underlying instrument though you have borrowed a significant amount of the money from the brokerage in order to take the position. Both Margin Trading and CFD offer different benefits, though it should be noted both pose significant risks. 

I am going to lay out a number of bullet points showing the important differences between the instruments:

  • Leverage – CFD’s generally give the trader the opportunity to trade with significantly more leverage, this is due to the fact there is no exchange of a physical asset going on. With the extra leverage CFD’s offer greater possible returns as well as the possibility for greater losses. 
  • Spreads – Margin Trading has the advantage of offering tighter spreads on the instruments offered this is due to the fact that Margin trader is essentially using a broker with Direct Market access who makes their money by charging commission on trades. 
  • Liquidity – CFD’s (Specifically those offered by Market Makers) generally provide better liquidity than Margin Trading. There may be times when Market conditions mean there is very limited Market liquidity meaning trade size may be limited. As CFD’s do not require the trader to own the underlying instrument they wish to trade. 
  • Stop Losses – Again Margin Trading customers can generally not use Guaranteed Stop losses due to the fact there is no guarantee that a trade can be closed at a particular market price. 
  • Account Size – You will generally find Margin Trading requires new traders to deposit a significant amount of money in order to be able to trade the financial markets. While Contract for Difference providers will accept customers depositing as little as $5, though this would involve taking on a significant amount of leverage with every trade. 
Margin Trading is probably better suited to traders with significant capital at their disposal. Though you will find many professional traders who operate both Margin and CFD trading accounts to take advantage of the benefits offered by each form of trading.

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