Stock is an investment that allows an individual to purchase a share and own a small legal part in the company. A stock market offers a mutual partnership between a company that offers shares looking to gain financial money to grow, and an individual looking to invest and to potentially earn profits as the company grows. When the company profits, you are paid a portion of the dividends based on the number of shares of stock you may own.
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CFD Trading in the Stock Market
For example, John runs a small bakery but knows the popularity of his baked items and wants his business to grow. But John needs capital to expand his bakery business. He currently has £20,000 and calculates that he would need £100,000 to spend on a proper space, equipment and furniture, talented bakery staff, and other goods to increase his business.
The solution for John is to choose ‘Stock’ and divide ownership of his business. Each stock has a value and depends on what a company is worth. John requires £80,000 to expand his bakery. He divides his business into 4 even shares and convinces 4 partners to invest £20,000 each. Now John and his 4 partners each own 20% of the bakery business.
In 4 years, the business has flourished, and John has opened two more bakery outlets. His bakery
business is now worth £1,000,000. John got the capital he needed without borrowing money or paying
any interest. He and his partners also increased their initial investment from £20,000 to £200,000.
There is potential profits, but there are possible risks and losses associated with stocks as
Types of Stocks
The multinational companies and corporations usually offer two types of stocks to raise money, and those are ‘Common or Preferred’. The stock mostly available for the general public to invest in is the Common stock, which allows all kinds of buying, selling, and trading of stocks. But as a proportionate owner, you are liable to share both the profits and losses of the company.
The Preferred stock is different as you would need to pay more money to get it. The main advantage is that, for instance, if the company suffers loss or goes bankrupt, the people owning Preferred stock will be paid the dividend before the ones owning a Common Stock.
How a Stock Market Work
A company offers stocks to the public through a term called ‘Initial Public Offering’ (IPO). The stockholders can resell sell the shares after the IPO; if as a trader, you expect the earnings of the company to rise, you can increase the price of the stock to earn a profit. There are two ways to get returns on your investment1. The first way is to for you to sell the share you own at a higher price than when you purchased it. If the company you bought a share from does not perform well and the value of its share decrease, then you could lose your investment, so it is key to buy shares of a company that is performing well in a financial market.
2. The second way is by getting profit through dividends that are quarterly payments distributed depending on the value of a share the company is worth
Forces that Drive the Stock Market
Stock or share price is driven by different factors, but at a given time in the market, the price is determined by current supply and demand. The stock prices are also driven by fundamental and technical factors and market sentiment. Some specific factors that affect stock prices are
- Introduction of new product
- Annual Report of the company’s earnings and profits
- Future growth
- Economic stability or instability
- Interest rates
Stock investment VS CFD Stock Trading
In stock investment, as a trader, you take ownership of the underlying stock, and you accept both the profit and loss. Whereas Contract for Difference (CFD) is a derivative product in which you speculate on the price of the underlying asset (stock) and do not own the asset itself.
In stock trading, you pay the full value of the share upfront and cannot risk losing more than you invest. CFD trading allows you to take advantage of the leverage and put up only a small fraction of margin but take the full value of the market exposure. But both share trading and CFD trading offers you the chance to take advantage of price movements and diversify your portfolio.
· Trade only in shares or Exchange Traded Funds (ETFs)
· Pay full price of the shares
CFD Trading on stock
· Use of margin and leverage and not having to buy or own the asset
· Go Long or Short to try to profit
The Concept of Margin Trading in Stocks
Trading on margin means borrowing money from a financial service provider to open a trade. In technical terms, the margin is the difference between the total value of the asset in your trading account and the amount of money loaned from the financial service provider.
Margin trading means as a trader; you borrow money to pay trade CFDs on stocks when the money in your trading account is insufficient to trade more volume with CFDs on stock or any other security. The financial service provider lends you money and allows you to trade more volume with CFDs on stocks. Leverage products can increase both profits and losses.
Trading CFDs on stock increases your trading power and allows you to potentially magnify your profits, but due to leverage-
it is considered quite a risky strategy that can magnify losses.
You have to open a ‘Trading Account’ to start CFD trading. Your account is held as collateral against the margin loan you will receive. The financial service provider has the discretion to set the terms of the loan and how much equity you have to maintain. When you ask to add a certain amount of cash or security in your account, it is called ‘Margin Call.’ Usually, an initial margin of 50% is required to open a position.
For example, you trade £200 of CFDs on stock and fund this transaction half (£100) by cash from your trading account and a half (£100) from the money loaned from the financial service provider. If the stock price jumps by 20%, the worth of your investment will now be £240.
You can close your position, and return the £100 you borrowed from the financial service provider. You will be left with £140, with a profit of £40. But if, for instance, the value of a stock is decreased by more than 20%, it would result in sufficient loss as you would have no gain.
Trading CFDs on stock has the potential of substantial gains but also the risk of significant losses, so prior steps must be taken before doing trading to try to reduce the risk
The information above is for education purposes only and cannot be considered as investment advice. Past performance is not reliable indicator of future results.
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