Before you start buying and short selling shares, you need to make a decision of what platform you are going to use and what is the preferred form of buying and short selling shares. For that purpose, a user has two options – via share trading platform (also known as traditional brokerage firm), or via Contract for Difference (CFDs).
There are some major differences between the two forms of trading shares as each one comes with its own pros and cons. It all depends on the resources you have to trade and what you are ultimately trying to achieve. So, in this article, we’ll help you understand the key difference between trading CFDs and share trading, and help you figure out which one is better for you.
What is the Difference Between Trading Shares Outright and Trading CFDs?
The most notable difference between trading stocks outright and contracts for difference is that when you buy and sell a CFD contract you are essentially speculating on the price of the asset without owning it. In other words, the CFD market is sort of a derivative market where traders gain exposure to stock global markets and can speculate on the price movements of underlying assets versus the broker or other market participants but without owning and exchanging the underlying asset.
For example, if you are buying shares of Apple via a traditional brokerage, you basically own security or a paper that shows you have ownership in the company. Therefore, you own a portion of the Apple Corporation, and you are entitled to dividends and other benefits that shareholders receive. For that matter, you need a brokerage firm that connects you to the exchange where you can directly buy Apple stock.
When you trade CFDs, on the other hand, you have no ownership and you do not receive any security or paper when you make a purchase. Instead, CFDs work in a way that you simply enter into an agreement with your brokerage firm or another investor who will pay (or receive) the difference between the price you enter the position and the share price at which you closed it. Because CFDs are a derivative form of trading done outside a stock exchange, brokers have the ability to offer retail traders key features that make this type of trading product very attractive (and risky). These include low fees, high leverage ratio, advanced trading platforms at no cost, the ability to short sell stocks with no margin requirements, and more.
What are CFDs?
CFDs are complex instruments that allow traders to enter an agreement with a brokerage firm about the future price of an underlying asset.
CFD Trading vs Share Trading – Pros and Cons
Apart from the above, there are other crucial differences between trading shares via a traditional brokerage firm and trading shares via CFDs. Below, you can find some of the pros and cons of each way in which you can trade shares.
|Trading Shares Outright||You get ownership in a company and you are entitled to shareholder privilegesActive traders may receive rebates; You get access to the real market including level 2 order book; You get market access to a wider range of stocks||High feesHigh margin requirement if you want to short sell shares; You need to pay annual management fees; Because there are strict requirements to open a margin account, you can only buy shares and make profits from rising prices|
|Contract for Difference (CFDs)||Low fees, only spread – make CFD trading cheaperHigh leverage ratio(typically around 5:1 or 10:1 for shares)Low minimum deposit requirement; Some brokers pay dividends when you hold share CFDsMost brokers provide access to financial markets including foreign exchange markets, commodity global markets, ETFs, cryptos, indices, etc.||Overnight fees – CFDs are less suitable for long term positionsCFDs can be quite risky due to the high leverage ratio; No voting rights; Trading CFDs with spreads makes it difficult to get in and out of positions|
Example of Stock CFD Trade vs Stock Outright Trade
For many people, the difference between trading stock CFDs and stock trading outright is somewhat vague and unclear. So, if things are not yet clear for you, an example is the best way to clarify the difference between the two forms of buying shares.
|CFD Trade||Share Dealing Trade|
|Pfizer stock price||$42.0 – $42.05||$42.0 – $42.01|
|Fee||Trading spread + overnight free||Trading spread, fixed fee, and annual management fees|
|Number of Shares||100||100|
|Funds Required to Open the Position||$420.5 (with a leverage ratio of 10:1)||$4201|
|Close Position at||$45||$45|
|Profit/Return in %||$295/70%||$295/%7|
Should You Buy and Short Sell Stocks via CFDs or Outright?
So, taking the above into consideration, you eventually need to decide what’s the best way for you to trade stocks – CFDs or directly from the exchange? My honest opinion – if you are planning to make a long term portfolio of stocks (including dividend stocks) with a large investment, it would be better for you to open an account at a traditional brokerage firm and pay one time commission when you buy and sell assets and annual management fees.
The reason for that is that when buying stock CFDs, you need to pay an overnight fee. It’s not a high fee but it might impact your decision to hold stocks for long periods of time, particularly when you are in a losing trade.
Another reason to trade via share trading broker is in case you want to get access to a level 2 order book, which helps you get the ‘feeling of a market’. With a level 2 order book, you get to see the buyers and sellers, quantities of each trade, stock market action, etc. This is a feature that is not available with CFDs.
Further, share trading brokers usually provide access to all stocks listed on a certain stock exchange. For example, if you open an account with a traditional brokerage firm, you’ll be able to trade thousands of shares from various exchanges including penny stocks. In comparison, CFD providers typically provide a limited selection of popular and highly traded stocks.
On the other hand, if you are planning to actively trade stocks and get in and out of positions several times a day or a week, then CFDs might be the better option. The logic behind that is obviously the high cost of buying shares outright. When you trade shares on a traditional brokerage firm, meaning you buy shares directly from the exchange, you need to take into account an average fee per trade of around $5-$8. In simple terms, you need to pay a fee of $5-$8 when you enter the position and when you close the position.
So, assuming you buy 100 shares of AT&T at a price of $26 and the fee per trade at your brokerage firm stands at $7 per trade, you’ll be profitable only when the share price rises above $26.14. Not something crazy, it could definitely happen – but for a day trader, that is a lot.
With CFDs, you simply don’t pay any fixed trading commissions. Instead, you pay a spread between the bid and ask price and the overnight fee.
What’s more? obviously the budget you want to invest in. Usually, share trading brokerage firms require a high amount of initial capital to open an investment account. For a margin trading account, most traditional brokers maintain a minimum deposit of $2000-$5000. CFD brokers, on the other hand, enable users to start trading with low deposits, and the account creation process is easier than with traditional brokers.
Additionally, short-selling shares via a traditional broker are quite a complicated process when compared to a CFD provider. This is why most people use traditional brokerage platforms to buy assets for the long term while trading stock CFDs is known as a better way in order to apply short-term trading strategies. There are no limitations to short sell shares, so a trader can easily make profits in rising and falling markets.
At last, leverage! This is, for some people, the primary reason to trade shares with CFDs. A leverage ratio of 5:1 or 10:1 for stock trading is a lot, as shown in the example above. With an investment of $1000, you can essentially trade the markets with $5000 or $10,000 (depending on the leverage ratio provided by the broker).
With that in mind, you need to remember that a leveraged CFD trade is a double edge sword – it certainly increases the potential for profits but also increases the risks involved in trading and the risk of losing money rapidly.
If you are a short-term trader looking to open an investment account with a low initial investment and get access to high leveraged trading as well as margin trading, you should trade stocks CFDs. Otherwise, as we mentioned above, the ideal way for long-term investors is to buy stocks via share trading broker or private investment banks.
The Bottom Line – CFDs vs Stocks?
To conclude, there are major advantages to each form of share trading. The key difference between CFDs vs stocks is the ownership of the underlying asset. This basically means that trading CFDs comes with margin and low trading costs and, therefore, is more suited for short-term traders. Meanwhile, share trading via traditional brokers is known as an ideal form of stock investing for long-term investors.
Finally, in order for you to make the right decision, below we have matched the best form of share trading for each type of trader or trading strategy.
|Type of Trader/Trading Strategy||CFDs/Share Trading|
|Long Term Investor||Share Trading|
|Swing/Medium Term Investors||CFDs|
|Day Trader||Both – Depending on the budget and the trading strategy|
|Low/Medium Budget Trader||CFDs|
|Professional Traders/Level 2 order book||Share Trading|
|Trading Strategy – Short sell Positions||CFDs|
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