CFD vs Stock Trading: What Is The Difference?
What is the difference between stock CFD vs stock trading? Trading stock CFDs is, in some ways, very similar to trading shares on the equities market. However, there are some key differences.
When considering CFD vs stock trading, 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 is a CFD stock?
|When trading with CFDs, a trader enters into a contract between themselves and the CFD provider whereby an agreement is made to exchange the difference in the value of an asset between the time the contract is opened and closed.|
This method of trading brings advantages, disadvantages and differences from traditional investment, which we will explore in the following sections.
Before we analyse all the differences between stock CFD vs stock shares, the concept of leverage deserves its own section, as this really is a key selling point of trading CFDs.
CFDs are leveraged products, whereby traders can trade on margin and, therefore, are not required to tie up the full value of a transaction. This allows 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, this value is known as the margin.
Of course, it must be noted that leveraged share trading is also available for investors. However, typically speaking, the leverage offered is usually significantly lower. It is also not as commonplace for online brokers to offer retail traders access to leveraged share trading, when compared with CFDs.
Leverage can be a very useful tool for a trader. By accessing larger positions, traders can expect 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 can enjoy leverage of 1:5 on stock CFDs. 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 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 CFDs?
Because leverage is incredibly risky and 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.
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Stock CFD vs Stock Share Trading: The Key Differences
Apart from what we have already described above, there are more key differences between stock CFD vs stock share trading. In this section, we will examine the advantages and disadvantages of trading stock CFDs.
Advantages of Stock CFD Trading
Let's look at the advantages of stock CFD vs stock shares trading. CFDs can be traded both long and short, moreover, you are not required to deliver the underlying asset in the event of a short sale. This feature of CFDs allows traders to speculate on both rising and falling markets, 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 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 Stock CFD Trading
It's time to look at the disadvantages of trading stock CFD vs stock shares. Trading CFDs 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 CFD trade incurs an interest charge if left open overnight.
This fee 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 via CFDs will end up incurring a lot of fees.
The other main disadvantage of trading stock CFDs 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.
Difference Between Stock CFD vs Stock Share Trading: Are CFDs a Good Investment?
When considering stock CFD vs stock shares in trading, many people ask, "Are CFDs a good investment?". The short answer to this question is no. Most traders do not consider CFDs for a long term investment. Because CFDs are volatile and incur high fees if held for long periods of time, traders usually consider them as short term trading instruments.
If we are considering whether stock CFD vs stock shares are better for investing, we can say that due to the disadvantages of CFDs mentioned above, many traders consider stocks more suited for long term investments.
Hopefully, after reading this article, you have a better idea as to the key differences between stock CFD vs stock shares in trading. The advantages and disadvantages of 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 CFDs on over 3,300 shares and over 300 Exchange-Traded Funds (ETFs), all 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.
CFD vs Stock Trading FAQ
What are CFDs?
Contracts For Difference (CFDs) are instruments that allow traders to speculate on an underlying asset, without ever actually owning the asset in question. Instead, a contract is established between the trader and their CFD stock broker whereby they agree to exchange the difference in value of the asset between the date of the contract opening and closing.
What is a Stock CFD?
A stock CFD is a contract between a trader and their broker to exchange the difference in value of a specific stock between the opening and closing date of the contract.
What is Share Trading?
Share trading is the process of buying and selling shares (stocks) of a publicly listed company. The buying and selling of shares in public companies is controlled and managed by a stock exchange such as the London Stock Exchange or New York Stock Exchange.
What is Leveraged Trading?
Leverage involves using borrowed capital to facilitate an investment. As a result, the potential returns and losses are magnified.
What Are the Costs of Trading CFDs?
Leveraged CFDs incur interest charges ("swap" fees) if left open overnight. The other main disadvantage of trading stock CFDs is that you don't actually own 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 Illegal?
CFDs are banned in the United States due to restrictions from the Securities and Exchange Commission. There are several countries in which citizens and residents are permitted to trade them in listed, over-the-counter (OTC) markets. The list of these countries includes some European states, Canada and New Zealand.
Trade with Admirals
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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.