CFD Trading vs Investing & Share Trading


CFD (Contract for Difference) trading and investing in stocks are two different ways to get involved in the financial market. Both of them have their unique features, objectives, merits, and drawbacks, which often makes it more complicated for the newcomers to opt for one of them.

This article will explore the main difference between CFD and share trading, letting you make the right choice and benefit from the increased profit.

The article covers the following subjects:

What’s the Difference Between CFD Trading and Investing?

To find out the difference between CFD trading and stock investing let’s look into their distinctive characteristics.

CFD Trading

CFD is a form of derivative trading that has soared in popularity during the last decade. It allows investors to speculate on the price movement of the financial product between the open and closing trades. CFD product range includes shares, indices, commodities, Forex, crypto, etc. CFD distinctive features can be revealed through the following five properties:

  1. Ownership. CFD investors never own the asset itself, they get the profit due to the fluctuations in the asset price. It means that CFD traders don’t need to buy or sell physical gold, for instance, they just speculate on its price change.
  2. Leverage. When trading CFDs, investors have a much smaller capital outlay since they deposit only a small amount of the total trade value to open the position in the market. However, both profits and losses are calculated using the full value of the product. Therefore, when dealing with CFDs, speculators have to face the risk of losing the initial investment.
  3. Going long and going short. CFD allows investors to benefit from both rising prices (going long) and falling prices (going short).
  4. Markets. CFD trading comes with an opportunity to trade on more than 15000 markets with around-the-clock access.
  5. Taxes. CFDs don’t require stamp duty, however, it’s necessary to pay capital gain tax. 

Investing

Investing in stocks (also known as share dealing) is one of the most common and easy ways to dive into the financial market. It implies buying some stocks of a public company that you believe will perform well in a long-term projection. Let’s consider investing in terms of properties used to describe CFD peculiarities.

  1. Ownership. When investing in stocks, in contrast to CFD trading, an investor is a total owner of the asset and may possess some shareholder privileges.
  2. Leverage. An investor has to pay the full value of the financial product. Yet, it makes it less risky since the losses can’t exceed the cost of the investment.
  3. Going long and going short. Share dealing can be profitable only in case the asset price is rising.
  4. Markets. Investing allows you only to buy shares and ETFs (Exchange Traded Funds).
  5. Taxes. Both stamp duty and capital gain tax have to be paid when investing in stocks.

CFD Trading vs Investing in Brief

Property

CFD Trading

Investing in Stocks

Ownership

No

Yes

Leverage

Yes

No

Going long and going short

Yes

No (only profit from the asset value increase)

Markets

Over 15 000 including Forex, commodities, cryptocurrencies, indices, etc.

Only shares and ETFs

Taxes

Capital gain tax

Stamp duty and capital gain tax

Trading hours

Around-the-clock 5 days a week

Only during the working hours of the Stock Exchange

Time Frame

Short-term

Long-term

Share CFDs vs Share Deal Example

A CFD trader wants to buy 1000 stocks of a fictional company “AAA” with a purchase price of $40 per share. It means that the price for this financial product will be $40000 (1000*40).

CFD on Shares Trading

CFD traders don’t need to pay $40000, they use the leverage of 1:20, and usually pay only a 5% margin, thus, in our example 1000*$40*5%=$2000. The rest of the sum is lent by the broker. There are two ways how a CFD trader can operate:

  1. In case he thinks the company will do well in the market, he opens the long position and profits if the price for this product rises. For example, if the price at closing is $45, the profit will be ($45-$40)*1000 shares=$5000.
  2. In the opposite situation when the investor predicts the fall of the price he opens the short position and benefits if his predictions come true.

In this example it’s important to remember:

  1. The investor doesn’t own the assets;
  2. Although the investor pays only the margin both profits and losses are calculated from the full value of the product.

Share Investing

  1. Investors can only profit from rising prices, opening long positions. In this example, if the price at closing is $45, the profit will be the same as with the CFD deal $45000-$40000=$5000.
  2. Investors get the ownership of the product, which may allow them to receive dividends, have voting rights, and benefit from other shareholder privileges.
  3. The highest risk is limited to the investment amount. In the “AAA” example, it means that the investor can’t lose more than $40000.

CFD Trading vs Investing: Pros and Cons

To help you decide what to opt for, traditional investing or CFD trading, let’s sum up their main advantages and disadvantages.

Advantages of Trading CFDs

  1. High leverage opportunities. CFD trading ensures higher leverage in comparison to traditional trading. Nowadays, the margin is capped in a range from 2% to 50% offering the leverage from 50:1 to 1:1 consequently.
  2. Global market access. CFD brokers provide investors with around-the-clock access to a great variety of markets.
  3. No shorting restrictions. Since a CFD investor doesn’t own the underlying asset CFD instruments can be shortened at any time.
  4. A vast variety of trading opportunities. Trading platforms offer Forex, indices, gold, commodities, crypto contracts for difference, etc. letting investors gain diverse trading experience in contrast to exchanges.
  5. No day trading rules. Some markets come with a certain limit on the number of day trades or minimal amounts of capital for a day trade. CFD markets don’t set any of these requirements.
  6. No stamp duty. In contrast to share dealing, CFD speculators don’t need to pay this tax.
  7. Lower cost. CFD trading tends to be more cost-effective not only due to the absence of stamp duty but also due to the lower broker fees in contrast to traditional sharebrokers.
  8. Sell and buy positions. CFDs traders have an opportunity to earn in both falling and rising markets.

Disadvantages of Trading CFDs

  1. High Risk. Leverage is a double-edged sword. On the one hand, it increases the potential profits, but, on the other hand, magnifies the losses. Moreover, CFD is a fast-moving and fast-developing type of trading. Thus, it requires continuous monitoring and a well-considered investment strategy not to face the loss.
  2. No shareholder rights. As CFD traders don’t own the underlying assets they don’t possess shareholder privileges such as voting rights in the company.
  3. Weak regulation. The CFD sphere lacks regulation. Although there are many credible CFD brokers, before choosing one it’s necessary to examine their background. Moreover, it’s crucial to check the local law system as CFDs may not be legal in some countries. For example, being over-the-counter (OTC) products, they are forbidden in the USA.
  4. Spread. CFD traders have to pay the spread, which is the difference between buying and selling price. Thus, if traditional markets slightly reduce investors’ profits by introducing various fees, commissions, regulations, etc. CFD markets do that through the spread.

Advantages of Investing in Stocks

  1. Ownership stake in a company. Investing in stocks is one of the instruments to become a minority owner in a company. The investor receives the right to vote and participates in company leadership.
  2. Manageable risk. The potential loss is limited to the amount of the initial investment.
  3. Liquidity. Stocks usually possess high liquidity, thus can be easily bought and sold at a fair price.
  4. Easy to begin. Investing in stocks is one of the easiest and most transparent ways to enter the financial market.

Disadvantages of Investing in Stocks

  1. Risk. The stock price is very volatile, it grows and falls instantly due to the company policy. So, as well as with CFDs, investors have to face the risk of losing much money if they don’t have enough experience or don’t understand what they are doing. The higher the return the bigger the risk of bearing the losses.
  2. Time-consuming. Investing in stock is a complicated task that requires much technical analysis and research. Not only do investors need to choose the right stock to buy but also constantly monitor its behavior in the market.
  3. Commissions and fees. Brokers usually charge investors every time they buy a stock. The commission when buying shares can be up to 1% of the portfolio value.

What to Choose: CFDs or Share Trading?

CFDs will be a suitable form of trading for you if:

  1. You are interested in a great variety of markets and want to diversify with ease;
  2. You consider the option of going both long and short;
  3. You want to use the leverage;
  4. You don’t care about owning the asset.

Investing in stock will be an efficient solution for you if:

  1. You are comfortable with paying the total value of the trading position;
  2. You prefer global stocks and ETFs;
  3. You want to be an owner of the underlying asset;
  4. You are investing in opening only long positions.

Final Thoughts

CFD trading or share dealing, what should I choose? Both of these trading forms have their merits and drawbacks, however, the final choice depends on your personal preferences and the possibility to accept the risk. CFDs are used in short-term trading and require a robust investment strategy and strictly conducted market analysis since the potential profits and losses can be increased from the leverage. Investing in stocks is used for long-term trading purposes and carries fewer risks due to unleveraged accounts.

Thus, to make the right decision and benefit from trading in the financial market, it’s crucial to conduct thorough market research, weigh up all pros and cons, and choose the trading form that complies with your personality.

CFD Trading vs Investing FAQ

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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