Trading shares directly

Before considering the difference between investing/trading the CFDs tied to different types of assets (shares, indices, FX), retail investors must ask themselves a question: if the margin requirements increased, why not trade the underlying products directly? Whatever an individual decides, they should always consider a product’s suitability to their circumstances (risk appetite, availability of capital, etc.). That said, CFDs are very accessible to retail clients and are more efficient in terms of capital being used.

If you typically trade £10,000 worth of shares in any of the UK Index blue-chips, like Barclays, Lloyds, BP and Vodafone, what are the chances that their share prices will fall all the way to zero? It sounds rather unlikely, doesn’t it? In which case, why tie up the entire £10,000 sum until the price rises to your desired profit target, paying both commission and an extra 0.5% stamp duty for the privilege?

By funding an Accendo Markets CFD account with the exact same £10,000, you can open an equivalent £10,000 position in any of those companies using just a 20%/£2,000 deposit. The remaining £8,000 sits on your account, either as extra margin for this trade or for other trading opportunities that might catch your eye.

If you fund with only the minimum £2,000 required for the same position, half (£1,000 in this case) serves as breathing room for the position, allowing it to fall by up to 10%, before it is automatically closed out to limit your losses, providing you with a 10% safety buffer. In the rare case where shares fall suddenly by more 10%, you can still never lose more than the full value of your initial 20% deposit.

To keep any trade open, you must ensure that you always have sufficient funds on your account to meet the minimum margin requirement for that trade (in this case £2,000).

Complex environment

When trading shares and share CFDs, investors must consider things such as corporate results (the company’s and its peers’), consensus forecasts, broker updates, the economic environment and technical indicators.

When analysing the index CFD, the number of things to take into consideration grows by several orders of magnitude. Indices may seem like monolithic financial products on the outside, but each is comprised of tens, hundreds, even thousands of constituents, each pushing and pulling on the index.

On any given day, each of the UK 100 companies can have a positive or negative influence on the index, for their own reasons. To many retail investors, keeping track of such a huge quantity of companies and all the other external influences (FX, geopolitics, sector read-across, etc.) is simply too daunting.

Measuring volatility

Investors often believe that equity indices like the UK 100 , DAX and Nasdaq offer bigger tradable swings, volatility and profits because of their exposure to a multitude of geopolitical and macroeconomic factors, such the global trade conflict or Brexit.

When markets are in an established trend, upwards or downwards, it can sometimes seem easier to put your money into the UK Index 100 blue-chip index rather than stock-pick individual names, which can move in different directions to the general market. But while seemingly more straightforward, buying and selling index CFDs doesn’t necessarily offer the same potential returns as a more in-depth research-based approach can bring.

For those investors who prefer holding financial instruments over the long-term, indices offer a mixed bag of recent results. The UK 100 is flat since the beginning of the year, while being only +0.7% in the past month. Currencies have fared similarly. Cable (GBP/USD) is -0.7% over the last month and down -2.9% since the beginning of the year. In daily trading, major indices rarely move more than 1-2%, while currencies typically exhibit even lower levels of daily volatility. (Source: AlphaTerminal, 1 August 2018)

By comparison, individual UK 100 shares can regularly offer 5-10% daily ranges. Major companies such as BT and BHP Billiton are up more than 7% in the last week, whilst trading -13.2% and +13.5% year-to-date, respectively. (Source: AlphaTerminal, 31 July 2018) Whether you are a proverbial bull or a bear, buying or selling equities, individual UK 100 components have just as much potential (in some cases even more) to offer superior trading ranges, whether holding those shares for the long-term or while trading the daily high-low range.

Indices vs. Equities

To compare volatility across different asset classes, let’s look at the recent stock market moves, both intraday, over the last 5 trading days, as well as over the last 5-year period.

In these tables, we are contrasting performance of the general market against a major component of the same market, the Anglo-Australian mining conglomerate BHP Billiton.

Both intraday movement and longer-term performance show greater volatility for equities compared to the overall index. The share price moves are greater on shares, potentially opening the door to bigger profits (but also losses) for investors.

Not all equities behave the same, of course, and different shares can see varying point swings. Moreover, some companies can be naturally volatile due to their industry or business model (e.g. Banks, Miners).

Astute investors tend to look for evidence of controlled volatility, where they can match an expected large swing in a share price with a specific event. This allows investors to be prepared for volatility in advance and anticipate a big point move.

On the next page, we discuss specific factors that investors need to pay attention to if they wish to spot significant share price moves.