CFD vs Stock Trading: Why Trade Stock CFDs?
What is the difference between CFD and stock trading? Stock CFD trading is, in some ways, very similar to trading shares on the equities market. However, there are some key differences.
When considering CFDs vs stocks, one such difference, and probably the most obvious to those familiar with financial derivative products, is that when trading with Contracts For Difference (CFDs), the trader never actually owns the underlying asset, in this case, a company's shares. There are other differences between the two and, in this article, we will examine some of these.
Table of Contents
CFD Stocks: An Introduction
For those of you who are unsure about CFD vs stock trading and what CFD trading is and how it works, here we will briefly explain the concept.
Contracts for Difference (CFDs) represent an agreement between two parties to exchange the difference in an asset’s price from the time the contract is opened till the time it is closed. It’s possible to trade CFDs on a vast range of assets, without ever taking ownership of the underlying asset.
So, what are stock CFDs? Stock CFDs are CFDs traded specifically on the shares of publicly listed companies.
As with other assets, stock CFDs track the value of a specific company’s shares. When a trader opens a position with stock CFDs, they agree to trade the difference in price of the company’s shares between the time they open and close the contract.
This method of trading stocks using CFDs is very different from actually buying a company’s shares. In the remaining sections of this article, we will examine the difference between CFD vs stock trading as well as highlight the advantages and disadvantages of stock CFD trading.
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CFD Stocks: Leverage
Before we analyse all the differences between stock CFDs vs stocks, the concept of leverage deserves its own section, as this really is a key selling point of trading stock CFDs.
CFDs are leveraged products, meaning traders can trade on margin and, therefore, are not required to deposit the full value of a transaction, allowing traders to open larger positions than they would otherwise be able to. To open a leveraged position, the trader needs to deposit a percentage value of the position, which is known as the margin.
Of course, it must be noted that leveraged stock trading is also available for investors. However, typically speaking, the leverage offered is usually significantly lower. Furthermore, it is also not as commonplace for online brokers to offer retail traders access to leveraged stock trading when compared with CFDs.
Leverage can be a very useful tool for a trader. By accessing larger positions, traders can free up capital to make more trades and will receive larger returns when the market moves in their favour.
However, it is very important to bear in mind that as well as having the potential to magnify profits, leverage will also magnify losses if the market moves against you. Therefore, taking this into account, leverage must be always used with the utmost respect.
Leverage Example
With a Trade.MT5 account from Admiral Markets, retail traders who trade stock CFDs can enjoy leverage of up to 1:5. Let's say then, for example, that you wanted to buy 100 shares of Apple, which were priced at $130 per share.
This would result in a total position size of $13,000. However, with if you were to trade stock CFDs with leverage of 1:5, the required margin would be 20% (or 1/5th) of this figure, meaning that you would actually only need an outlay of $2,600. Thus, you are left with more capital to utilise on other trades, should you wish to do so.
Can You Lose More Than You Invest in Stock CFDs?
Because leverage has the potential to magnify losses as much as it can magnify gains, there is the chance that you can lose more than the initial capital you used to enter the trade. This is why, as stated earlier, it is important to treat leverage with respect and to implement good risk management, such as always trading with a stop-loss.
CFD vs Stocks: Key Differences
Apart from what we have already described above, there are several key differences between CFD vs stock trading. In this section, we will examine these differences and highlight the advantages and disadvantages of trading stock CFDs.
Advantages of CFD Trading
We have already examined the benefit of leverage for stock CFDs trading, but let’s look at some other advantages of using CFDs vs stocks.
CFDs can be traded both long and short and you are not required to deliver the underlying asset in the event of a short sale. This feature of stock CFDs means traders to speculate on both rising and falling share prices, which is a big selling point for CFDs.
For example, if a piece of news is released which you think will negatively affect the share price of Company A, you can open a short position using stock CFDs. If you are correct and Company A's share price falls, you will profit from this downward price movement.
Furthermore, in the UK, CFDs are exempt from stamp duty, however, all profits are subject to capital gains tax.
Disadvantages of Trading CFDs
Now, let’s look at the disadvantages of CFDs vs stocks.
Stock CFD trading using leverage can be a useful tool, as discussed above. However, because when trading on leverage the broker is effectively lending you the capital to open a larger position, a leveraged stock CFD trade incurs an interest charge if left open overnight.
This charge is known as the "swap" fee. It is normally based on the full market value of the open position and the rate will be set by your broker. The swap fees charged by Admiral Markets can be viewed in the Contract Specification section of our website.
Naturally, if you were to buy shares using your own capital, you would not be exposed to this charge. This means that if you are looking to buy shares to hold onto them for a longer period of time, doing so using stock CFDs will end up incurring a lot of fees.
The other main disadvantage of stock CFD trading comes as a result of not actually owning the underlying company shares. Company shareholders usually enjoy additional rights, such as voting rights when the company is making key decisions. Trading stock CFDs means that a trader will not benefit from this right as they are not a shareholder.
Suitability of CFDs in Trading
When evaluating the differences between CFD (Contract for Difference) trading and stock trading, it's important to understand their distinct characteristics. One common query is about the suitability of CFDs as a long-term investment. Generally, CFDs are not typically seen as ideal for long-term investment strategies. This perspective is largely due to the higher fees associated with holding CFDs over extended periods, leading many traders to view them as more appropriate for short-term trading scenarios.
In the context of comparing stock CFDs and traditional stocks for investment purposes, it's essential to consider the unique aspects of each. Given the aforementioned challenges associated with CFDs, particularly for long-term holdings, traditional stocks often emerge as a more favorable option for those looking to invest over a longer time horizon. This preference stems from the structural differences and fee implications between the two types of investment vehicles.
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Conclusion
Hopefully, after reading this article, you have a better idea as to the key differences between CFD vs stock trading. The advantages and disadvantages of stock CFDs, when compared with buying shares, are also key points for traders to remember.
There is no definitive answer as to which of these financial instruments is better, as it depends on each trader’s individual profile and purpose as to which instrument will be better suited to them.
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Frequently Asked Questions
What are the main differences between CFD trading and stock trading?
- CFD Trading: CFDs allow you to speculate on the rising or falling prices of assets without actually owning them. They are derivative products where traders agree to exchange the difference in an asset's price from when the contract is opened to when it is closed. CFD trading often includes leverage, which can amplify profits as well as losses.
- Stock Trading: This involves buying and owning shares of a company. As a shareholder, you own a portion of the company and can benefit from dividends and stock price appreciation. There's no leverage involved in traditional stock trading, so the potential gains or losses are limited to the amount of money invested.
How does the use of leverage differ in CFD and stock trading?
- In CFD trading, leverage allows you to gain a large exposure to a financial market while only tying up a relatively small amount of your capital. However, it's important to remember that while leverage can amplify your profits, it can also magnify your losses.
- Stock trading typically does not involve leverage. Your potential profit or loss is directly related to the performance of the stock you own. The maximum loss is limited to the total amount invested, unlike CFDs where losses can exceed the initial investment.
What are the risks and benefits of each type of trading?
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CFD Trading Risks and Benefits:
- Benefits: Potential for high returns due to leverage, ability to go short and profit from falling prices, access to a wide range of markets.
- Risks: High risk due to leverage, potential for large losses, not owning the underlying asset.
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Stock Trading Risks and Benefits:
- Benefits: Ownership of a portion of the company, potential dividends, limited risk (to the amount invested).
- Risks: Capital at risk if the stock price falls, no leverage to amplify gains, less flexibility in short-term trading compared to CFDs.
Remember, both CFD and stock trading have their own set of complexities and risks, and it's crucial to understand them fully before investing.
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