May 30, 2023
Understanding CFDs vs. Share Dealing
Both CFDs and shares, or stocks, have advantages and disadvantages when it comes to trading. The two products are vastly different, so before deciding which is right for you, you’ll need to understand both the differences in the debate over CFDs vs. stocks, and also learn how the two are intertwined with and related to each other.
In this article, we’ll break down the advantages both CFDs and shares have, their downsides and the difference between CFDs and share trading.
CFDs vs. Shares
The main difference between CFDs and shares is that CFDs – contracts for difference – are leveraged financial products, while shares are not. This one difference has huge ramifications for how each can be used within an investment portfolio, the knowledge you’ll need to trade them and the fundamental and technical analysis you’ll be required to perform in order to manage them successfully.
Let’s get into more detail about each of these options for traders.
What are shares?
Shares are probably familiar to most people, and even if you haven’t started trading or investing directly, you may be exposed to share trading through your superannuation fund. Shares are a unit of equity in a company or an ETF (exchange traded fund); owning them entitles you to certain voting rights and a share of that company’s profits.
The worth of your shares is derived from the value of the company on a stock exchange. This value, or share price, can move up and down, and you may also receive payouts, known as dividends, from your shares.
Leverage isn’t available when investing in shares; this means that your profits will likely be more modest, but also that your losses can not be more than your initial investment. If you invest £1,000 and the price of your shares drops to zero, the most you will lose is all £1,000, but will not exceed this amount.
What are CFDs?
CFDs, or contracts for difference, do not represent ownership of a particular asset in the same way shares do. They are a financial instrument that works by allowing you to speculate on the movement of an asset or an index’s price. When trading CFDs, the trader does not take ownership of that underlying asset – any profit or loss is derived from the movement of the spot price itself.
CFDs are often used for trading based on shorter term price movements, or to hedge your existing positions to mitigate against loss. Hedging is possible with CFDs, because they are a product which allows you to both go long or short (i.e. buy or sell), depending on how you think the market will move.
As we’ve mentioned, CFDs are leveraged financial products. Trading with leverage means that only a percentage of the total trade’s value is needed to open a position. This is also known as the margin, and it is calculated by a company to produce a margin rate.
If a CFD has a margin rate of 20%, for example, opening a £1,000 position would require a £200 deposit. Leveraged trading opens up the opportunity for larger profits, but also carries the risk of larger losses, because any outcome is based on the total value, not just your capital deposit.
Learn the difference between CFDs and share trading
Another way of thinking about CFDs vs. shares is that trading shares is buying into a company’s equity, whereas CFDs are betting on an outcome of the market. This major difference means that there are lots of ways where trading shares or trading CFDs offer very different options:
- Leverage and cost of position — The fact that CFDs are leveraged means that they offer a lower barrier to entry; you only need to put up a margin in order to gain full market exposure. Shares require you to put down a larger cost of position by comparison; you’ll need to pay for the full amount that the stock is worth upfront.
- Risk — Leverage amplifies everything: your potential profit and your risk. Shares can move to £0 value, but you will only ever stand to lose the value of your initial investment. If you open a position on a CFD and the market moves in the wrong way – against the position you were betting – you have the risk of absolute loss, with all of your CFD positions moving to zero. Your loss could also outstrip your initial outlay, just as your profits could be magnified if the market moves your way.
- Flexibility — CFDs are generally considered to offer more flexibility than shares, because you can bet on the success or failure of the market, you can go long or short and you can offset your trades relatively quickly and with less money required to gain full market exposure. This is why they’re a popular product for advanced traders looking to speculate on intraday market movements, a strategy known as day trading.
- Trading hours — CFDs can be traded outside of traditional market trading hours, however, there may be charges or extra fees associated with out-of-hours trading. With CFDs, you have the freedom to potentially trade 24 hours a day, while shares are normally constrained to local stock exchange trading hours.
- Available markets — Both CFDs and shares have large available markets in which you can begin trading. Shares can be bought and sold on global markets, as can ETFs.
CFDs are available in many international markets, and you can use CFD trading strategies to gain exposure to commodities, bonds, shares, indices, cryptocurrency, currency pairs, ETFs and more.
- Opportunities for short selling — If you’re looking to go short on a position, CFDs will likely be the right choice for you. Stocks do not offer short selling on all platforms, and the opportunities for shorting stocks are not as dramatic and therefore as attractive as with CFDs.
- Privileges and dividends — When investing with the aim of receiving dividends and shareholder privileges, you’ll need to take ownership of stocks, rather than CFDs. CFDs are never connected to ownership of the underlying asset, whereas holding shares will pay out dividends and in some cases give you company voting rights.
- Complexity — Shares are an abstract concept to a certain extent, but they are a tried and tested financial instrument with a fairly straightforward system of trading and of value fluctuation.
CFDs, by comparison, are more complex by orders of magnitude. They also can quickly fluctuate in price, which increases the risk of suffering a rapid loss. Risk management strategies like stop orders and limit orders are helpful when controlling this level of complexity and protecting against loss.
- Diversity — Both stocks and CFDs are options for diversifying your portfolio, depending on how they are used. CFDs could be added to a portfolio to hedge your current positions, and for giving you full market exposure to an asset you may not already have open positions with.
Because CFDs are traded purely on the movement of the market, it is more likely that a portfolio of exclusively CFDs would drop to absolute zero. Trading a combination of stocks and CFDs is one approach which would give you both long positions, short positions, opportunities for large profits and less volatility.
What CFD markets are there?
CFDs are available to trade in a number of markets; soft commodities, energies, precious metals, bonds, stocks, indices and more. At VT Markets, we offer CFDs in markets around the world, including:
Because CFDs offer out-of-hours trading, it’s possible to open up an assertive suite of positions with share CFDs in an international market, even if it’s not within the same time zone as you.
Now that you know which CFD markets are available, you’re ready to learn more about how to trade CFDs with our detailed guide.
Trade your way with VT Markets
Whether you want to start trading stocks, CFDs or you’d like to diversify your portfolio with a range of both, VT Markets can help you. We’ve built our brokerage services around powerful trading platforms, MetaTrader 4 and MetaTrader 5, in order to give our clients an easy and flexible trading tool that’s transparent, competitively priced and completely reliable.
Creating an account with us only takes a few minutes – simply fill out a few details and you’ll be ready to fund your account and start operating in a live trading environment. You’ll also gain access to state-of-the-art trading tools, daily market analysis, investor insights, guides to the fundamentals of trading, detailed economic calendars and so much more.
If you’d like to practise opening and closing positions before you move into the markets, take advantage of our free demo account. When you sign up for a demo account, you’ll receive a free 90-day trial where you can get comfortable operating in a live trading environment, without any risk or obligation. Activate your live or demo account today, or talk to our team for all the help you need in building your trade portfolio.
FAQs
Is it better to trade CFD or shares?
Both shares and CFDs have their own advantages and disadvantages that may or may not suit your goals and your style of trading.
Shares are considered to be a more straightforward financial instrument that are good for taking long positions, and grant you certain privileges as a shareholder in a company or ETF.
CFDs, on the other hand, are good for presenting short term opportunities, are easier to buy into with full market exposure and give you the flexibility to hedge your existing positions or go against a market if you so choose.
Is trading CFDs better than investing?
Because CFDs require you to trade on the margin, it costs less upfront to get the same level of exposure to the equivalent value of shares. CFDs can also be used to offset other investments, and both CFD trades and share investments can be used together for a more diverse and protected portfolio.
Are CFDs riskier than stocks?
Because CFDs are leveraged financial products, they amplify both your profit and loss margin. It’s important to have a good understanding of these complex financial instruments and how they work before you start trading with them. As with many financial products, their potential for high profits comes with an increased potential risk, and even small movements in the markets can be amplified as losses.
For this reason, risk management tools like stop loss orders and limit orders are useful when managing CFD positions.
To learn more about Forex and CFD trading, visit our Learn Forex page for further information!
