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Trading CFDs and stocks can look similar in different ways. They both allow you to make money if the stock price moves in the right direction. However, there are major differences between stocks and CFDs including ownership, execution, leverage, and losses.
In stock trading, you become the physical owner of the stock, while CFDs - or contracts for differences - only allow you to trade on the basis of price movement, or speculations.
CFDs were introduced way after stock trading. Nowadays, almost every broker will offer you CFD trading because it is more flexible and enables you to amplify your potential for gains based on a small investment. But does it mean that CFD is better than stock trading? Not necessarily.
We have conducted a detailed analysis of the difference between CFD trading and stock trading. After reading this guide, you will have knowledge about how they differ, and what risks and benefits they include.
Corporations may release their stocks to be traded to the public. When a trader buys shares in a company, they own a stake in that company. By physically owning a stock, if the stock price increases, the shareholder can sell the stock back to the market. This way, traders gain the difference between the purchase price and the current price as a profit.
Stocks are traded in stock exchange markets such as the New York Stock Exchange, NASDAQ stock exchange, and other stock exchange markets around the world, where numerous companies are listed to be publicly traded.
You need to find a financial broker that enables you to access the stock exchange market, only then can you place your bids to buy and sell stocks, according to to live stock prices.
There are other benefits that you can enjoy from owning a stock physically, such as receiving dividends, if the company pays out dividends to shareholders. Additionally, some stocks give you voting rights, so you can vote on some administrative decisions, appointing the board of directors, and so on.
Contracts for difference, aka CFDs, function a bit differently than classical stock trading. While trading CFDs you only predict the outcome of the stock price changes, and you don't actually own a company's stock.
Through CFD trading you can place two types of market orders: buy and sell options. The buy order is placed when you predict that the price will increase for the upcoming period of time, so you can close your market position and gain the price difference as a profit.
“There is a time to go long, a time to go short and a time to go fishing.” - Jesse Livermore
The sell order in CFD trading is placed when you expect the stock price to decline in the near future. Then you gain from the difference between the purchase price and the current market price.
In CFD trading, you enter an agreement with the CFD provider, and according to the contract, you exchange the value of the stock between the purchasing price and the closing price. Therefore, if the difference is positive, you make a profit. Otherwise, if the difference is negative, you incur losses.
Using CFDs, you do not enter the stock exchange market. Rather, you are dealing with the broker. Therefore, in CFDs, the broker has more control over the terms and conditions, and they may pass some of this flexibility to the trader, which helps the trader to maximize their projected profits.
We have already gone through the fundamentals of classic stock trading and stock trading using CFDs. In order to understand which one you need to trade, we will go into more detail on the following elements:
In stock trading, you physically own the stock, and as a shareholder, you enjoy other benefits such as dividends and voting rights. You can later decide to sell the share(s) that you own when the price has increased enough to make money.
However, in CFD trading you do not become the owner of the stock, because you are only trading on the speculation of the price change, and your gain/loss is defined by how the stock price changes as long as the CFD is active.
Trading stocks implies owning or selling different stocks, which means that you are paying the whole price of the share, and when it rises in value, and you sell it, you gain the price of the whole share.
If you are buying more than one share, then you multiply the price of one share by the number of shares you want to own. In classic stock trading, you cannot buy or sell a fraction of the share, or borrow money from the broker.
On the other hand, CFD is a leveraged trade, and it is the main point that distinguishes CFD trading from classic stock trading. Using CFD trading, traders can get involved in much higher market positions than they would do using their own money. In this case, the broker lends money to the trader to open market positions using a bigger contract size.
Using a margin account you can only pay a fraction of the stock price, while the remaining amount is borrowed from the broker, which is called leverage.
This way, leverage can help you magnify your gains using a smaller budget from your trading balance if the trade goes favorably. Otherwise, the leverage can amplify your losses if the trade goes sideways.
When you buy shares in a company, you aim at holding the stock until the stock price increases, then you can sell the stock to gain some profit, or you can keep holding the stock if you predict the stock price will keep climbing, so you can gain bigger returns later.
Similarly, if you buy the stock and the price drops, your security is becoming cheaper. You can either sell it to avoid additional losses, or you can keep it if you hope or predict the price will pick up again in the future.
Using CFD trading, your gains or losses are determined by the stock prices when you close the CFD contract.
If you open a buy order and the price increases, then you are making a profit. But if the stock price decreases, it means that your market position is losing. This type of order is also called a long order.
On the other hand, if you open a sell order and the price increases then you are incurring losses, but if the stock price decreases then you are gaining on your market position. This type of market order is also called short order.
In classic stock trading, if you buy and hold a stock that later declines in value, your only risk is if the price drops below the purchasing price, or if the drop was significant and the stock price becomes zero.
Let’s say the stock became worthless, your security now has no value, and you do not incur additional losses.
However, using leverage with CFD trading can be risky. When you borrow money from the broker to trade on a higher-value market position, if the market price goes against you, you lose your money, and the broker loses the money they lent you.
This way, your trading balance can drop into a negative, and you become indebted to the broker. Then you will need to repay the broker either by funding your account or by selling any security you have under the same trading account.
Note that by using margin, brokers protect themselves from excessive losses by initiating a margin call when your trade position becomes at risk of losing. You are asked to add funds to your account or the broker will close the trading position to protect its money.
If you prefer classic share trading, where you own a stake in a specific corporation, you have two options: the first is buying stocks in company equity, which means you purchase shares of a company.
The second option is to invest in an ETF, an Exchange-traded fund, which is a basket of securities and assets where you can buy and own ETF shares, and trade according to how the price changes. ETFs can be a better choice for beginners because they entail less volatility.
CFDs are a type of contract that can be used with any type of security and tradable asset. CFD can be used to trade currencies, stocks, stock indices, commodities, precious metals, and many more market options.
CFD trading is helpful to trade faster because it implies predicting the upcoming price of a specific security, without the need to physically own that security.
In normal old-school stock trading, a trader is tied to the stock exchange market working hours. For example, the US stock exchange market operates from Monday to Friday, opens at 09:30, and closes at 16:00 EST. Meanwhile, the Tokyo stock exchange market works the same days but operates between 09:00 and15:00 Tokyo time.
So, a stock trader can purchase and sell stocks only during these working hours.
However, in CFD stock trading, an investor can place any market order at any time during the 5 working days, which means 24 hours a day, 5 days a week.
CFD trading only requires a broker, because a brokerage firm can provide the CFD contract to traders. Most brokers work 24/5. This allows traders to speculate on the markets’ prices before the stock exchange markets open, and after they close as well, which can be an advantageous feature of CFD trading.
In the stock exchange market, the broker has no control over the buying and selling rates or transactions done by the traders. When a broker gives direct market access to stock traders they can use the bid and ask prices directly from the market.
Therefore, stockbrokers usually apply a fixed charge on both sides of the trade. Every time a trader buys and sells a stock, or enters and leaves the market, there is a flat fee imposed by the broker.
On the other hand, with CFD brokers, there are different types of charges that may exist, including spreads, rollover, and holding fees.
Spreads are the usual trading fees, but they are not charged separately; rather, they are incorporated in the bid and ask prices that are offered by the broker in the CFD trade. Rollover charges take place when a trader keeps the market position running overnight.
We cannot say that one type of trading is better than the other as both CFD trading and stock trading have their pluses and minuses. Based on the trader’s expectations and experience, they may choose how they want to trade after looking at the list of pros and cons.
CFDs allow traders to open positions on expensive stocks. CFD brokers allow leverage, so the trader can use borrowed funds from the broker to open market positions on higher-value stocks. While in stocks, a trader needs to pay the whole price of a stock.
No, a CFD does not allow you to physically own the stock. Rather, CFD trading allows you to trade based on your expectations of the stock price, and you gain if the stock price moves in a favorable direction according to your market order.
Unlike owning a stock, CFD stock trading does not qualify traders to receive dividends. However, some brokers may process a cash adjustment to cope with dividend payments. Only shareholders can receive dividends if the company pays dividends.
A contract for difference does not have an expiration date, you can open a market position using a CFD and keep it as long as you want. The CFD contract ends when you close your market position and receive whatever gains or losses resulted during the trade.