CFD vs Stock Trading: Why Trade Stock CFDs?
What is the difference between CFD vs 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
What Are CFDs?
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.
What Are Stock CFDs?
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.
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.
An Example of Leverage
With a Trade.MT5 account from Admirals, 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.
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Stock CFDs vs Stocks: The 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 Stock 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 Stock 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 Admirals 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.
Are CFDs a Good Investment?
When considering CFD vs stocks in trading, some people may ask, "Are CFDs a good investment?". The short answer to this question is no. Most traders do not consider CFDs appropriate for a long term investment. Because CFDs incur high fees if held for long periods of time, traders usually consider them only as short term trading instruments.
If we are considering whether stock CFDs vs stocks are better for investing, we can say that due to the disadvantages of CFDs mentioned above, stocks are better suited for long term investments.
CFD vs Stock Trading - Final Thoughts
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.
Trade Stock CFDs with Admirals
If you are feeling inspired to start trading, you might like to know that with a Trade.MT5 account from Admirals, you can trade stock CFDs on over 3,300 shares and over 300 Exchange-Traded Funds (ETFs) from the world's largest stock exchanges!
Other benefits include access to leverage and free use of the world's number one multi-asset trading platform, MetaTrader 5! Click the banner below to open an account today:
Please note: Tax treatment depends on your individual circumstances. Tax law can change or may differ in a jurisdiction other than the UK.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.