CFD vs Stock: Which is Better For You?
You have many options if you're considering investing for your future, including common instruments like stocks and the increasingly popular CFDs. But what are they exactly? Is one better than the other? How exactly do stocks and CFDs work?
This detailed comparison article will answer all these questions, so you're better informed to make the best choice.
Start trading or investing in stocks right now with Interactive Brokers!What is CFD?
Contract for difference or CFD is a financial trading instrument where the investor enters into a contract with a broker that stipulates that the investor must pay the difference to the seller the difference between the current value and the value at the time the contract ends of an asset.
CFD does not give ownership of the asset as such because the investor is not buying the asset, only speculates the price change of the asset, and pays the exchange.
The underlying assets for CFDs can be stocks, commodities, foreign exchange, and other financial securities. The CFDs on shares are called CFD Stocks.
CFDs are mainly used for high-leveraged trading because CFD trading is traditionally a high leverage instrument. That means investors can trade on margins without necessarily putting in all the money.
Other uses of CFDs include active trading. Investors can speculate on certain assets' near future market movements and invest in CFDs to make quick profits. Investors and wealth managers also sometimes use CFDs to hedge share portfolios. You can also be interested in information abou best CFD signal providers to maximize profits trading CFD.
👍 Pros
• Access to financial assets at a lower price than actually buying it
• It can be traded both short and long
• High-leverage trading on margin
• Access to lots of assets and different markets globally
👎 Cons
What are Stocks?
Stocks represent ownership (equity) of a fraction of a publicly listed company. This gives stock ownership of the company's assets as well as profits as per the number of stocks they own. These stocks are traded on a stock exchange, for example, the London Stock Exchange or the New York Stock Exchange.
Stocks are usually seen as a long-term investment as the price of a stock may increase steadily under normal conditions. This instrument can also yield dividends, which is basically the company's profit among the stockholders, quarterly, semi-annually, or annually. However, that varies by company and depends on how well the company did in a year.
You can buy and sell stocks through brokerage firms, all of which are done online these days.
👍 Pros
• Potential for higher returns (average annual return of 10 percent)
• High liquidity
• Some stocks can yield dividends which can serve as passive income
• Easy to buy and sell
👎 Cons
• Risk of losing the entire investment ( plus no guaranteed returns)
• Prices go up and down frequently
Main Difference Between Stock CFDs and Stocks
Here's a quick comparison chart before we discuss the differences further:
| Stocks CFDs | Stocks | |
|---|---|---|
Company’s share ownership |
No |
Yes |
A right to receive dividends |
No, though you can get price adjustment |
Yes |
Voting right |
No |
Yes |
Leverage |
Very high (up to 1:1000) |
Low (up to 1:3) |
Shortable |
Yes |
Yes |
Swap Charged |
Yes |
No |
Risks |
High |
Average |
Property rights protection |
Average |
High |
Share Ownership
With stocks, you get the actual ownership of the company as represented by the number of stocks. The more stocks you buy, the more ownership you have, and you actually own those stocks.
In comparison, stock CFDs do not give any ownership of the stocks. It's just a contract on the stock price changes with the CFD provider.
Dividends
While not all stocks may pay dividends, some stocks do, usually in the form of cash or further shares of the company. Usually, the companies pay dividends after adjusting for taxes and investing the profits back into the company, so it highly depends on the company's performance.
Stock CFDs do not pay dividends per se, but they do offer cash adjustment based on the dividends paid to stockholders. Typically, an amount matching the company's dividend is added to the trading account.
Voting Rights
With stocks, the stockholders traditionally get voting rights, typically one vote per share. However, those voting rights are very limited as the executives and board still make most day-to-day decisions of directors of the company.
There are no voting rights with CFD stocks, as there's no direct ownership of the stock.
Leverage Level
The biggest difference between stocks and stock CFDs is that the latter is very high leverage, which is what makes it attractive for some investors. Buying stocks directly is low leverage.
To understand this, you must understand leverage. Simply, high leverage allows investors to enter into large positions with less capital. For example, you can buy stock CFDs worth $20,000 without actually paying that amount upfront. This leaves your capital to invest in other instruments.
High-leverage investments like stock CFDs are considered high-risk-high-reward investments.
Shortability
Short positions are possible with both stocks and stock CFDs. Traders can sell stocks and buy them later at a lower price if they speculate the share prices will go down. However, shorting is even more cost-effective with stock CFDs as there are no borrowing costs.
Swaps
Unlike stocks, stock CFDs are subject to swap charges which are incurred on overnight CFD trades.
Risks
Stock CFDs are high-risk investments because of the leverage. This is because the price moves represent a higher percentage of the margin. Suppose you have paid a margin of 20 percent, i.e., deposited 20 percent of the total stock CFD amount. If the underlying stock price goes down by 20 percent, you will lose the entire capital you have invested.
In worse scenarios, the losses can also be higher than the capital you initially invested, which means.
Buying stocks is not without its risks, such as the stock prices going down or the company going bankrupt. However, the risks are still lower as compared with stock CFDs.
Rights
Again, stocks offer much better investor rights protection because of the ownership factor that you own the stock. With stock CFDs, the level of protection depends on the regulations in the country you're in or where the CFD broker or provider is based.
Find out about the Best stock CFD brokers in the TU article.
CFD vs Stock - A Real Life Example
For instance, you buy ten stocks of Tesla for $9000, with one stock priced at $90 at the time of purchase. In this case, you'll be charged a broker commission by the broker you use for buying the stocks, which typically ranges between 1-2 percent.
Some brokerage firms charge zero commissions on the purchase and sale of stocks.
On the other hand, when you buy 10 Tesla stock CFDs, you'll pay the initial deposit based on the leverage. While that would be significantly lower than $9000, you will have to pay some other costs as well.
These costs include the spread (the difference between the instrument's buy and sell price) and overnight funding if you hold the position after the stock market has closed. However, the latter may be added or subtracted from your account the next day.
Top 10 stocks to invest in right nowCFD vs Stock - Which is Better for Active Trading?
CFDs are generally a high-risk investment suited for seasoned investors who have better knowledge of the market. CFDs present better opportunities for active trading than stocks as they can yield higher returns in a short period, provided the investor has played their cards right.
If you're a beginner going in for active trading and want to reap the benefits that CFDs offer, you should ideally begin with CFDs with relatively lower leverage. Alternatively, you may want to go with stocks that you speculate will see a dramatic value increase in the short run.
CFD vs Stock - Which is Better for Investing?
For long-term investment, stocks are evidently better than stock CFDs. The difference between CFD and stocks makes the latter a more suitable option for long-term investment because of low leverage and no rollover costs.
Plus, stocks are relatively safer and offer better investor protections because a central authority regulates the stock market. Therefore, you can even go big with the capital. However, as always, diversification of shares is advised to reduce risks.
Best Brokers for CFD Trading and Stock Investing
FxPro - Best for CFD Trading
FxPro is a UK-regulated foreign exchange broker that also offers FX CFDs. Its main advantages are transparent pricing and exposure to a wide range of CFD products. It's also one of the best in terms of the liquidity market, which is a common concern with CFDs.
Interactive Brokers - Best for Investing
If you're interested in stocks, Interactive Brokers is a reliable broker that offers stocks from some of the most competitive markets, including the ones in the US. In addition to buying shares of companies, you can also invest in exchange-traded funds (ETF) shares, which track indices.
It's a global platform with a wide range of products offered for every market. The tools are quite helpful for both beginner and advanced traders. But the biggest benefit is that it offers lower margin interest rates as compared with the industry average.
Summary
CFDs are relatively newer investment instruments than stocks that have been trading for ages. The main difference comes down to ownership and leverage. Buying stocks gives you ownership, while CFDs don't.
CFDs are high-leverage investments where you don't have to deposit the full value initially, but it is also what makes it very risky because you could lose your entire investment. CFDs are good for active investing and better suited for experienced investors.
FAQs
Are CFDs cheaper to trade than stocks?
The commission on stocks makes them more expensive to invest in than CFDs. However, the difference is becoming smaller and smaller, thanks to zero-commission brokers.
What is a Stock CFD?
A stock CFD is a contract on the value of a particular stock between a trader and a broker that centers on the value exchange at the end of the contract.
Are CFDs legal?
CFDs are legal and regulated in many parts of the world. At the same time, CFD trading is banned in some countries, like the US and Brazil.
What assets do CFDs follow?
CFDs are commonly available for stocks, stock indices, commodities, ETFs, and foreign exchange.
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Team that worked on the article
Mikhail Vnuchkov joined Traders Union as an author in 2020. He began his professional career as a journalist-observer at a small online financial publication, where he covered global economic events and discussed their impact on the segment of financial investment, including investor income. With five years of experience in finance, Mikhail joined Traders Union team, where he is in charge of forming the pool of latest news for traders, who trade stocks, cryptocurrencies, Forex instruments and fixed income.
The area of responsibility of Mikhail includes covering the news of currency and stock markets, fact checking, updating and editing the content published on the Traders Union website. He successfully analyzes complex financial issues and explains their meaning in simple and understandable language for ordinary people. Mikhail generates content that provides full contact with the readers.
Mikhail’s motto: Learn something new and share your experience – never stop!
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
The topics he covers include trading signals, cryptocurrencies, Forex brokers, stock brokers, expert advisors, binary options. He has also worked on the ratings of brokers and many other materials.
Dr. BJ Johnson’s motto: It always seems impossible until it’s done. You can do it.