CFD vs. Stock: What Is CFD Trading and Investing?

Trading CFDs (Contracts for Difference) or investing in stocks? This is the question that traders have to address before entering the financial market. While the latter has a long history and is familiar to the majority of investors, CFD is quite a new concept that is gaining widespread popularity. This article will outline the difference between CFDs vs. shares, their key features, merits and drawbacks, and everything else you need to know to choose the most suitable financial instrument for your investment portfolio.

What Is the Difference Between CFD Trading and Investing?

CFD trading and investing are two different ways to enter the financial market. The key difference between them lies in the concept of ownership over the underlying asset. When investing in stocks, traders have to pay the full value of the asset, thus becoming owners of a particular part of the company. Trading CFDs, in contrast, allows for speculating on the asset price fluctuations without buying the asset itself.
To find out other differences, let’s have a closer look at the distinguishing features of CFD trading and investing.

CFD Trading Explained

CFD, short for Contract for Difference, is a type of derivative instrument that can represent a big variety of underlying assets, such as stocks, commodities, indices, crypto, etc. It is an agreement between a trader and a broker to exchange the difference between the open and the close asset price. In contrast to investing (also known as share dealing) which is often used for long-term investments, CFDs are more popular among active traders.

CFD trading is considered to be more flexible, mostly because it allows for the use of leverage. Traders can get greater exposure to different markets with significantly lower investments. To open a position, they don’t have to pay the total value of the underlying asset but provide an initial deposit (aka margin). Let’s say that the asset price is $20 per share and a trader wants to buy 100 of them, when trading CFDs they won’t need to pay $2000, but only a fraction of it. For example, if the margin is 5%, the initial deposit will be $201005%= $100, the rest will be provided by the broker. However, like any other trading tool, leverage comes not only with potential benefits but also some pitfalls, the biggest of which is the increased level of risk. It’s crucial to keep in mind that when trading on leverage both profits and losses are calculated based on the total value of the position.

CFD traders don’t own the underlying asset. It means that they are exempt from the stamp duty, yet the capital gain tax has to be paid on any type of profit.

Investing Explained

Investing in stocks (also known as share dealing) is one of the most popular ways to get involved in financial markets. As it was mentioned above, it suggests buying stocks, thus taking ownership of a particular share of a company. Stock investors may also be provided with some shareholder privileges, such as voting rights, or dividends.

In contrast to CFD traders, share dealers can’t use leverage, meaning that they have to invest the full value of the position. For example, if company stock is traded at $50 per share, when acquiring 100 of them, investors will have to provide $5000 upfront. However, the potential losses are also limited to the amount of the initial deposit.

Compared to CFDs, which can be used in both long (buying) and short (selling) trades, stock investing implies opening only long positions. Moreover, in the case of share dealing, investors will be asked to pay not only the capital gain tax but also stamp duty. It’s crucial to note that both investing in stock and trading CFDs come with risk. Thus before opening any trades it is important to gain knowledge and experience in this sphere.

Leverage

Leverage is a feature of CFD trading that is often considered a double-edged sword. On the one hand, it is a robust tool that enables investors to get bigger market exposure and increase their potential profits while requiring smaller initial investments. But, on the other hand, it makes trading riskier, since not only profits but also losses are calculated using the full position value. For example, if the leverage is 1:20, to open the trade, investors have to provide only a 5% margin, however, their potential profit, as well as loss, could reach 100%. Leverage trading is not available for share dealing.

Going Long and Short

CFDs allow speculators to take advantage of both buying (long) and selling (short) trades. Moreover, there is no difference in opening these positions. Traders make their predictions, place trades on a certain trading platform, profit if their expectations turn out to be true, and suffer losses if the market goes in the opposite from the predicted direction. Direct investing in stocks, conversely, is only possible for long trades, when speculators reap the profits if the asset price goes up.

What Can I Trade?

CFDs offer traders exposure to more than 15000 markets with around-the-clock access, such as stocks, forex, crypto, commodities, indices, and more. When it comes to the share dealing, the range of assets is significantly smaller, it’s possible to invest only in stocks and ETFs (Exchange Traded Funds).

CFD vs. Investing Example

Let’s consider an example: a trader wants to buy 100 stocks of a fictional company “EX” when the buying price for 1 share is $150. It means that the total value of this position will be $150*100=$15000.

CFD Trading Example

Since CFD trading implies profiting from the difference between opening and closing asset price, traders can choose between opening either long or short trades. If they expect the price to increase, they will open a buying trade. Otherwise, if, in their opinion, the asset is going to drop in value, they will enter a selling trade.

In our example, the trader believes that the EX shares will increase in value, so he wants to open a buying position. In case the leverage is 1:20, he doesn’t need to pay $15000, but only $15000*5%=$750.

Winning Case:

Confirming the predictions of the investor, the EX company is going well on the market and its asset price increases up to $160 per share. In such a situation, the profit will account for ($160 - $150)*100 = $1000 minus any broker commissions or fees.

Losing case:

Company EX has been involved in a financial scandal, as a result of which its stock price suddenly decreased in value to $130 per share. In this case, the trader will suffer a loss of ($130 - $150)*100 = -$2000 plus any broker commissions or fees. Note also, that it is more than the initial investment.

The same pattern works for short trading. If the speculator predicts the asset price to fall, he places the selling trade, reaping the profits if his expectations about the asset price movement are correct.

Investing Example

To enter a share deal, the investor in our example will have to pay the total value of the position - $15000. Moreover, since it’s possible to profit only from increasing asset prices, he can open only a long trade. Taking ownership over the EX stock, he also becomes a shareholder of this company, which might offer him some privileges, such as dividends, voting rights, etc.

Winning case:

If the investor’s expectations are correct and the price of the underlying asset surges to $160, his profit will be ($160 - $150)*100 = $1000 minus broker commissions and fees.

Losing case:

If the asset price decreases to $130 against all the trader’s predictions, he will carry a loss of ($130 - $150)*100 = $2000 plus possible broker commissions and fees. Note that, in this situation, potential loss can’t exceed the amount of the initial investment.

CFD Trading vs. Share Dealing

To eliminate any ambiguities between CFDs vs. shares, let’s compare their features within particular concepts, such as ownership, markets, fees, taxes, and more.

Ownership

When traders invest in stocks, they buy the assets, thus, taking ownership of them. CFD trading suggests the direct opposite. CFD traders don’t own the asset, they profit from its price fluctuations. This can be particularly convenient when trading commodities since there is no need to buy and store physical assets (such as gold).

Finance

CFD trading comes with greater financial flexibility. Using the leverage, investors don’t have to commit total investment value, which allows them to open more positions and take advantage of a bigger exposure with potentially higher profits. In the example above, it’s possible to see that to open the same trade, a CFD speculator will need $750 while a stock investor - $15000. However, not only does the leverage have the ability to magnify profits but also amplify potential losses. Therefore, it’s recommended to trade CFDs only in case you have the necessary experience.

Markets

CFDs can be traded on a big variety of markets, including stocks, indices, cryptocurrencies, forex, commodities, etc. In share dealing, the number of financial instruments is limited to stocks and ETFs.

Fees

Both CFD traders and share dealers have to pay fees. CFD trading usually comes with brokerage commissions (in some cases) and spreads, which is the difference between the purchase price and the offer price. Investing in stocks implies a brokerage commission on every trade (either buying or selling). Its amount varies, depending on the trading platform regulations.

Cash Settlement

Stock trades usually require a settlement of several days (usually two business days after the trade occurs). CFD trading, in contrast, doesn’t have any cash settlement period, meaning that as soon as the trade is closed, traders can reap their profits or face the losses.

Taxes

Since CFD traders don’t own the underlying asset, they don’t usually have to pay the stamp duty. However, they will be obliged to put up the capital gain tax on any profit. As for the stocks, not only are they subject to capital gain tax but also the stamp duty. However, it’s necessary to remember that tax regulation of CFDs, stocks, and other financial instruments may differ from country to country. Therefore, before starting your trading experience, it’s advised to check the taxation rules of that particular place.

Hedging

While stocks can’t be used for hedging, CFD is a seamless instrument for this purpose. The concept of hedging implies that traders can open both short and long positions. This way, if one position (for example, long) suffers a loss, the opposite one (short) offsets it.

Market Hours

CFDs offer traders 24-hour access to over 15000 financial markets. Share deals can only be executed during stock exchange trading hours.

Short-Term vs. Long-Term Strategies

CFDs are more common for short-term trading strategies (day trading, intraday trading, etc.). Stocks, conversely, are more often considered a middle- or long-term investment. However, it doesn’t necessarily mean that traders can’t implement short-term stock trading strategies.

Platforms

Both CFDs and stocks are available for trading on numerous trading platforms such as nagamarkets.com. Moreover, online brokers often provide traders with free demo accounts so that they could try different financial instruments and choose the ones more suitable for their trading style.

Shareholder Privileges

Since CFDs come with no ownership of the asset, they don’t grant traders any shareholder privileges. Shares, in contrast, may offer investors the right to take part in the company voting process or receive dividends, if they are paid.

Long & Short Opportunities

CFD trading allows investors to choose between opening the buying (long) position if they expect the market to be in bullish sentiment and selling (short) positions if they believe that the asset price will drop in value. Stock trading, in contrast, can be profitable only in case the asset price rises, therefore, only long positions are considered.

Expiry Date

Neither shares nor CFDs can expire. CFD trades do not close automatically. Traders can exit them any time the asset price starts to move in the opposite from the predicted direction.