Contents: CFDs vs Stocks

• Should I trade CFDs or stocks?
• What is the difference between a CFD and a stock?
• CFDs vs stocks: Comparison
• Trading: CFD example vs stock example
• Advantages of CFDs vs stocks
• Is CFD trading riskier than stock trading?
• Is CFD trading cheaper than stock trading?
• CFDs for short-term trading
• CFDs to hedge stock positions

Should I trade CFDs or stocks?

Everybody has an opinion, especially in the investment world. Whether an equity trader opts to trade CFDs, trade stocks, or do both depends entirely on what they are trying to achieve and their own personal circumstances. In this article, we will explain the difference and hopefully help you decide which one might be better for your trading.

What is the difference between a CFD and a stock?

The major differences between a stock and a CFD are leverage and ownership. When you buy a stock, you take ownership of the shares, even if a stock certificate isn’t physically mailed to you. Stock investing is, in effect, buying a small ownership stake in a company you believe in. When you buy a stock, you also generally pay the full price for each share.

CFD stands for Contract For Difference. By practising CFD trading online, you can speculate on the price of a security without ever owning the underlying asset. This may be a stock or virtually any other fungible, liquid asset you can think of: a stock or other index, currency pair, commodity, or cryptocurrency. In contrast with stocks, CFDs normally trade on leverage, meaning you can enter a position with a smaller initial outlay of capital than its actual value. 

CFDs vs stocks: Comparison

Trading: CFD example vs stock example

Let’s start with stocks. In our example, you buy Apple stock with a bid / ask of $154.29/154.33

You buy 10 shares @ $154.33 and pay $1,543.30, plus whatever commission your broker charges.

OR:

You opt for CFDs instead, and buy 10. Assuming the spread is the same, this costs you $154.33, meaning you only deposit a 10% margin. Commission normally doesn’t apply but is baked into the spread.

Note that one stock CFD normally represents one share of the stock. With index CFDs, though, the CFD may represent 10 units of the underlying asset. Forex CFDs come in different lot sizes: 100,000, 10,000, and 1,000 all being common. This information can usually be found displayed prominently on the online trading platform you use. The order ticket will also show the margin requirement before you enter the trade.

Advantages of CFDs vs stocks

Leverage

Leverage offers the ability to enter larger positions with a smaller amount of capital. This exposes the trader to greater risk but also potential rewards. Arguably, this is an advantage if you know what you’re doing and a drawback if you don’t.

Go either long or short

To go long on a stock CFD you simply click the buy button. To go short you click the sell button – the process is exactly the same.

Access to lots of markets

CFD trading is done on most major asset classes including stocks, forex, commodities, indices, and more. Novice traders, however, might want to limit themselves to a single kind of equity, reducing the research overhead required to make intelligent trades.

24-hour trading

Online, CFD trades can be done at all hours of the day, making it more accessible to part-time traders and offering easier access to international markets. Most stock CFDs trade only during stock exchange hours.

Advantages of stocks vs CFDs

Simpler fee structure

Though this isn’t particularly relevant to day traders, owning a stock does not entail rollover fees, charged on positions held past market close.

Lower potential downside

When buying a CFD, you implicitly accept that your whole position may be wiped out – in fact, it’s possible you’ll be struck by margin calls and have to pay your brokerage more than you initially deposited. In theory, any given stock’s value can go to zero, but this happens only rarely and won’t affect a diversified portfolio that badly.

Asset ownership

Again, most day traders won’t care, but it’s worth mentioning that the process of paying dividends to CFD holders is rather complex, and they don’t get corporate voting rights.

Greater regulation and transparency

CFDs aren’t allowed in all countries; in some, they can be traded but financial authorities wash their hands of anything that may happen to investors. CFDs carry greater counterparty risk, meaning that your brokerage may default on their obligations. 

Is CFD trading riskier than stock trading?

The use of leverage adds extra risk because moves in the market you are trading are magnified. Each will represent a larger percentage of the margin you have deposited compared to if you paid the full amount and simply bought a stock. 

If you have deposited 10% collateral for an equity trade, the share price only needs to fall 10% for you to lose your entire deposit. Unless you used a stop-loss order, your losses can actually exceed that. However, more funds can always be added to cover margin calls, offering some flexibility if used carefully. 

A special case occurs when retail investors use CFDs to place trades in meme stocks and cryptocurrencies like Dogecoin. This seems like a strange thing to do: when trading very volatile stocks, it is just not necessary to use leverage. In this case, the risk and rewards are already high. 

Also, as mentioned, extra potential risk occurs in the form of counterparty defaults, but this isn’t significant if you use a reliable trading platform.

Is CFD trading cheaper than stock trading?

When trading CFDs, the cost of each transaction includes the spread and an overnight funding charge, and sometimes (though not normally) also a commission. Stock trading includes the spread paid to the stock exchange, custody fees and often commission, but never an overnight funding charge. 

CFDs for short-term trading

The ease with which you can go both long and short CFDs. as well as the leverage and overnight holding costs, means CFDs tend to be preferred for day trading and short-term trading strategies. Because of the one-time costs when buying or selling, stock trading is preferred for long-term investing.

However, this does not mean they can’t apply CFDs in their overall strategy. A popular circumstance in which a trader will do both stock trading and CFD trading is for hedging. This is typically where an investor wants to keep a long position in his stock portfolio open but wants to protect against short-term risk by going short on the stock’s CFD. The lower margin requirement on the CFD means it is a more capital-efficient hedge than shorting the stock, which is also more time-consuming.

Conclusion: CFDs vs stocks 

This article gives you the main pros and cons of each of these investment vehicles. However, we don’t claim to offer an exhaustive overview of the subject nor to have the last word. Forums like r/Daytrading are filled with proponents and detractors of each. 

In general, though, it all depends on your circumstances. Online, commission-free trading has made the cost of trading stocks more comparable with the cost of trading stock CFDs in recent years. The main consideration on cost is the intended holding period for the trade: high-frequency traders might prefer CFDs, buy-and-hold adherents would generally go for stocks.