A Guide to Trading Stock CFDs
Trading stock CFDs is, in some ways, very similar to trading shares on the equities market. However, there are some key differences.
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.
For those of you who are unsure what CFD trading is and how it works, here we will briefly explain the concept. 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 the two methods of trading, 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 are able to 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. In order 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, it is imperative that leverage is always used with the utmost respect.
An Example of Leverage
With a Trade.MT5 account from Admiral Markets, 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.
Stock CFDs: The Key Differences
Apart from what we have already described above, there are more key differences between buying shares and trading stock CFDs, in this section we will examine the advantages and disadvantages of trading stock CFDs.
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, again, 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.
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 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 in order 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.
Hopefully, after reading this article, you should have a better idea as to the key differences of trading stock CFDs and its advantages and disadvantages when compared with buying shares.
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 Admiral Markets
If you are feeling inspired to start trading, you might be interested to know that with a Trade.MT5 account from Admiral Markets, 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.
About Admiral Markets
Admiral Markets is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!
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.