Difference Between a CFD and a Stock

As an investor, I have traded both shares and share CFDs in my own capacity. When I first started, I was biased in favour of stocks. Perhaps like you, I just wanted to trade the "real thing" and avoid what I saw as unnecessary complexity.

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However, I have come a long way since and embraced CFDs on stocks. I hope to help you see the compelling arguments in favour of trading Contracts For Differences, over investing in stocks outright. Here are my top 5 reasons to trade CFDs:

1. Profit in rising and falling markets

As a share trader, your first trade will always be to buy stock. You cannot sell what you do not own. This may be right for you if the share is undervalued. However, if a share is trading above its fair value, you’ll need to wait for a dip before placing your first order. Waiting on the sidelines can be frustrating, particularly if there is money to be made from a fall in the price.

As a CFD trader, your first trade can either be to buy or sell share CFDs because you are trading contracts on the share price, rather than the share itself. This allows you to profit from a fall in the price of shares that you believe are trading above their fair value. There are countless strategies you could turn to to identify overpriced shares, whether you use moving averages or price-earnings ratios. However, a discussion of CFD trading strategies is beyond the scope of this article.

In short, trading CFDs opens up more ways to profit, whether prices are rising or falling. It’s always the right time to trade, if you have a clear strategy in mind. This is perhaps the argument I find most compelling in favour of CFD trading.

2. Borrow easily

As a share trader, you’ll probably be accustomed to buying shares outright in cash. You may also have used credit card debt to trade in the anticipation of higher returns.

As a CFD trader, your broker will allow you to borrow directly through your trading platform, at the time you place your order. Some brokers allow you to leverage up to 1,000 times your investment. However, EU regulated brokers now cap leverage to 30 times your investment across Forex trades.

You may view ease of borrowing as an advantage. However, borrowing is always an individual decision, whether you trade shares or CFDs. As a CFD trader, you can choose to avoid leverage altogether if you prefer to minimise risks. Leverage is always ‘flexible’ up and down, and never a requirement.

3. Dividends

As a share trader, you can look forward to both capital gains, from increases in a stock’s price over time, and dividends. Some stocks are classified either as “growth stocks” or “income stocks”, when gains are weighted in favour of one or the other.

People often assume that CFD traders aren’t entitled to dividends. However, this couldn’t be further from the truth. If you have a long position, your broker may credit your account by the dividend amount. Always ask your CFD broker about their dividend policy if you are in doubt.

We've sourced below what FxPro.com says about dividend payments:

4. Commissions and taxes

As a share trader, you’ll be accustomed to paying commission when you place an order. For example, dealing fees start at £11.95 with Hargreaves Lansdown and £12.95 with Barclays Stockbrokers, and are due for every buy and sell order (even when you exit a position).

In contrast, most CFD investors trade commission-free, with no monthly account fees. Instead, CFD brokers earn money through the spread between buying and selling prices, helping you save significant amounts of money over time.

In addition, you may also have to pay tax on your purchase. For example, UK investors are liable for “stamp duty”, currently 0.5% of the purchase amount. In contrast, no stamp duty is levied on CFD trades. You should enquire about the tax situation in your country.

5. Greater anonymity

If you are an individual investor, remaining anonymous may be the least of your worries. However, you should be aware that companies keep a record of their shareholders. American companies have the right to request the names, addresses and securities positions of their shareholders under Rule 14b-1(c) of the Securities Exchange Act. In contrast, buying and selling CFD has no such privacy implications. You will remain anonymous, except of course to your CFD broker.

Trading CFD is, in my opinion, superior to buying shares outright as it allows you to profit in rising and falling markets. You’ll be entitled to the same dividends as other investors and could save significant amounts in taxes and trading fees. In addition, you’ll also enjoy greater anonymity and keep your trading activity away from public records. If you would like to get started, compare Forex and CFD brokers through our service and open a live or demo account online.