Mastering stocks and indices
Ways to trade stocks
As with any financial market, there are multiple different ways to trade shares. In this lesson, we're going to focus on two: investing and CFD trading.
Investing in stocks is one of the most well-known forms of retail trading.
When you invest, you're buying a share in a company, as we described in the introduction to stock trading lesson. If the company increases in value, then your investment will increase in value too.
Stock exchanges only allow permitted personnel to buy and sell shares directly on their order books, so most retail investors use a stockbroker. Stockbrokers charge a commission to buy or sell shares on your behalf.
One significant benefit of investing is that you can receive dividends, which enable you to achieve a return from your stock without selling it.
What is a dividend?
A dividend is a portion of a company's profits that they pay back to shareholders. Many companies will choose to reward investors by paying a regular dividend: usually monthly, quarterly or annually. Some may also pay one-off special dividends, often after a period of particularly strong performance.
While they're usually paid out of net profits, sometimes you'll see a business pay a dividend despite a drop in earnings, to maintain demand for their stock.
How much you'll get from a dividend depends on how many shares you own. If you own 500 shares in a company that pays a dividend of 50 cents per share, for instance, you'll receive $250.
You could even build a portfolio that only targets returns from dividends, looking for stable blue chips that don't offer much growth but do make steady payments to investors. This is a called a dividend strategy.
Stocks tend to follow a set timeline when they pay dividends, from announcing the dividend on the announcement date to paying investors on the payment date.
Perhaps the most important day to remember, though, is the ex-dividend date (ex-date). You must invest in a company before the ex-date to be eligible for its dividend. Anyone that buys stock after will miss out.
We'll cover dividends in more detail in the corporate actions lesson.
Stock CFDs are a little bit different to buying shares with a stockbroker. They enable you to speculate on a market's price movements without owning the underlying asset.
When you open an equity position with a CFD, you agree to exchange the difference in a stock's price from that moment until you close your trade. You do this by trading a set number of contracts.
Each contract you buy or sell represents a single share of the underlying market. Buying 500 Apple CFDs will give you the same exposure as buying 500 Apple shares; selling 1000 Netflix CFDs is the equivalent of selling 1000 Netflix shares.
Like with investing, you'll pay a commission to execute your trade.
Because you don't ever own the stock, you won't be eligible for dividends with a CFD. However, you will be able to access leverage – which can drastically reduce how much you spend to open a position.
CFDs vs investing example
You want to open a long position on 100 Walmart shares when its share price is $130. To do so, you can choose between stock investing and stock CFDs.
Buying 100 shares at $130 gives you a total position size of $13,000. With investing, you'd have to pay the full $13,000 upfront.
With a leveraged stock CFD, on the other hand, you might only have to pay 30% of your position's full value at the outset. In this case, that means you'd deposit $3,900 as margin.
Your profit or loss would still be based on the full size of your trade in either case. If Walmart shares increased to $140, you'd make $1000. If they dropped to $120, you'd lose $1000.
However, because you only paid $3,900 for the CFD position, your return or loss is magnified.