CFDs vs Stocks: Differences, Similarities, and Which to Choose

In the financial markets, there is a plethora of financial products that can be traded. Given the right conditions, trading each one of the products can have the potential to create trading opportunities. But in the world of plentiful choices, it is crucial to choose the product that is right for you. In this article, we will address the choices between CFDs and stocks.

CFDs vs Stocks: Which one Suits you?

CFDs can be an option to trade if:

• You use a variety of trading styles based on market conditions
• You like the flexibility and nimbleness to get in and out of markets
• You are interested in trading in a variety of markets (stocks, forex, commodity, options, etc.)
• You don’t care about potentially owning the underlying asset

Stocks can be an alternative choice to trade if:

• You not only want to create trading opportunities for potential gains (which comes with the risk of losses), but you also want to participate in equity growth through ownership and control of the company
• You would like to be entitled to dividends given out by the company
• You have access to a much larger pool of capital

Similarities Between CFDs and Stocks

Both Allow You to Take Advantage of Price Movements

A Contract for Difference (CFD) allows traders the opportunity to take advantage of the falling and rising prices of underlying financial assets (the underlying).^[1]

A stock also allows both traders and investors to take advantage of the price movement of the shares.

Differences Between CFDs and Stocks

1. CFDs Allow Flexible Trading Styles Without PDT Rule

Are you a day-trader, scalper, or swing dealer? Do you primarily follow one pattern, or are you sometimes inclined to vary how long you stay in your positions based on what the market outlook is? CFDs can provide you with maximum trade flexibility for your preferred trading style. ^[2]

Contrast this with the situation in which you’re purchasing stocks. Yours or your broker’s jurisdiction will determine whether or not your broker is actively day trading stocks. If so, you will be subject to Pattern Day Trading (PDT) rules for each margin account that you are actively day trading stocks. This could make it challenging for small accounts.^[3]

2. CFDs Enable Short-selling

Traders can short a CFD position to possibly take advantage of falling markets. For example, you wish to trade Intel’s shares through CFDs at $2,060. You decided to take the short side of the trade for 50 contracts and will close the position as soon as the share price reaches $1,750 per share. This trade can potentially make a $250 profit since ($2,060-$1,750)*50 = $15,500. (This example is provided for illustration purposes only).

The owner of the stock always has a long position.

Stock traders who want to sell short are required to borrow shares from the broker. You then sell those and repurchase them later at a lower rate to take advantage of the falling markets. However, it can be difficult to borrow, especially for thinly traded stocks. ^[4]

It should be noted that when it comes to retail stock trading, borrowing shares from the broker is necessary. Selling short without first borrowing the stock, or at least first determining that it can be borrowed is referred to naked shorting – an illegal practice, as it can potentially lead to a failure to deliver. ^[5]

3. Transaction and Financing Costs

When trading CFDs, you incur transaction costs (fixed-ticket, bid-ask spread, or spread plus a small commission for direct market access, depending on your provider and your account type), as well as overnight swap fees. When trading options, you only pay the broker commissions.^[6]

4. CFDs are Leveraged Products

CFDs are a leveraged product, which means that you only need to deposit a small percentage of the full value of the position in order to open a position – you will be trading on margin, which is the amount of money you need to open a position. Margin trading gives you full exposure to the market while using only a small fraction of the capital otherwise needed.

Leveraged trading can work well for those trading short-term price movements due to the cost of borrowing whereas it would not be primarily preferred for anyone investing long-term.^[7]

Stock trading has two types of accounts: cash and margin accounts. Cash accounts will give you no margin. On a margin account, however, you borrow money from the broker using the securities in your brokerage account as collateral. As with any loan, you need to meet the maintenance requirements, which varies from broker to broker.

5. CFDs are Derivative Products

A CFD allows traders to take advantage of the falling and rising prices of underlying financial assets (the underlying). The fact that CFDs are derivative products means that they have a large variety of underlying such as stocks, commodities, forex, precious metals, and even options contracts. The price of the CFD is driven by the price of the underlying.^[8]

When the contract ends, the trader and the broker exchange the difference between a specific asset’s opening and closing prices. The trades can result in either a profit or a loss, depending on the direction that you have chosen.
A stock is not a derivative product. It represents a fraction of the publicly listed company, and the buyer of the stock owns a fraction of the company. A stock’s price, therefore, represents the company’s market value.

Conclusion

In conclusion, for short-term private investors who are not interested in holding an investment for the long term, they can consider online CFD trading to create opportunities from the price movements. By leveraging CFDs, investors can take advantage of market opportunities. If you tend to hold trades for a longer time frame that is greater than four to six weeks, and are interested in sharing the control of the company, stocks may be a good choice for you.

Reference

1.  “An Introduction to Contract for Differences (CFDs) – Investopedia.” https://www.investopedia.com/articles/stocks/09/trade-a-cfd.asp. Accessed 7 Apr. 2022.
2. “What Type of Trader Are You? – Investopedia.” https://www.investopedia.com/articles/investing/052413/what-type-trader-are-you.asp. Accessed 8 Apr. 2022.
3. “Pattern day trader – Wikipedia.” https://en.wikipedia.org/wiki/Pattern_day_trader. Accessed 8 Apr. 2022.
4. “Short Selling – Corporate Finance Institute.” https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/short-selling/. Accessed 8 Apr. 2022.
5. “The Truth About Naked Short Selling – Investopedia” https://www.investopedia.com/articles/optioninvestor/09/naked-short-selling.asp. Accessed 13 Apr. 2022
6. “How CFD Pricing Works | Contracts-For-Difference.com.” https://www.contracts-for-difference.com/cfds-pricing.html. Accessed 8 Apr. 2022.
7. “Leverage – Guide, Examples, Formula for Financial & Operating ….” https://corporatefinanceinstitute.com/resources/knowledge/finance/leverage/. Accessed 8 Apr. 2022.
8. “The underlying assets of CFDs – Forex-Central.net.” http://www.forex-central.net/cfd-underlying-assets.php. Accessed 8 Apr. 2022.