CFDs vs stocks – what you should know about trading them

You probably already know that you can buy physical stocks, wait for the price to increase and sell later to claim profits. But did you know that you can buy or sell stocks as Contract For Difference (CFD) and profit even in falling markets by short selling stock CFDs?

Stock trading comes with a host of benefits to traders. The shareholder and dividend privileges offered by some of the industry leaders can be attractive for many traders. However, direct share trading also has its limitations. The core issue being the reliance on only upside profit.

Many traders wish to gain exposure to equities in the short term without actually owning the stake in given companies.

Contracts for differences, or CFDs, are the most frequently used alternative alongside options.

CFDs give traders the opportunity to profit from price fluctuations in the short term, and gain substantial leverage while doing so.

Stock traders are often more interested in the long term potential of the underlying company – its regulatory compliance, market shares, financial performance, growth, etc. Hence, physical stocks are primarily an investment vehicle.

CFDs, on the other hand, are more focused on the short-term catalysts affecting the stock price.

This guide will look at the core principles behind stocks and CFDs and highlight what traders should consider when choosing between the two.

Choosing between stocks and CFDs – factors to consider

Stocks and CFDs are fundamentally different in terms of ownership, taxation ,regulatory oversight and the process of trading.

While stocks can be bought and sold for profit, which is only possible if the trader buys low and sells high, CFDs have the option of long and short positions to profit from the downside as well as the upside. When purchasing a physical stock, you gain the ownership of the asset. When trading stocks as CFDs, you do not own the asset, you are just speculating on the price, which makes it possible to make money even in bear markets.

CFDs also offer leverage to traders, which can boost purchasing power at a fraction of the capital invested by the trader.

In order to make a decision which is right for you, consider your trading strategy and whether the long-term perks offered by stock ownership is important to you at all. Short-term traders are not particularly interested in dividends, as they hardly ever hold an investment for a sufficient period of time to qualify for dividend payments.

While short-term trading is feasible for both stocks and CFDs, the benefits offered by stock ownership do not hold up as well in the short term.

CFDs are traded using leverage. When holding a large position using leverage, you have to pay the interest in the form of swaps to the broker that gave you the leverage. And the interest charged is what makes CFDs less desirable for long term investing. However, they are much better than physical stocks for short term trading.

Tradable assets

Stock trading refers to the buying and selling of equities, which includes stocks, exchange-traded funds and real estate investment trusts. No other assets qualify as stock trading.

CFDs are a broad family of assets that do not qualify as asset ownership. CFDs of assets such as stocks, forex, indices, commodities, cryptocurrencies, etc. are available to traders.

Profit & loss

The maximum upside for stock trades is limitless, while the downside is limited to the value of the position held in that stock. Thai is not the case for CFD trades. CFDs offer leverage and long/short positions – which in tandem can create highly risky trades with limitless downside.

These features may deter some risk-averse traders from incorporating CFDs in their strategy.

Entering a short position using CFDs can go badly if the stock price keeps increasing, as stocks do not have a price ceiling, and therefore, could theoretically increase in price forever. Trading using leverage means that you can lose more money than it’s on your account balance. Make sure that your broker offers negative balance protection before opening a CFD trading account.

Scope

Stocks, in principle, are assets with a long-term scope. Buying the shares of a newly listed company, or a startup, comes with promises of future profitability, disruptive products, innovation, etc. This is why more people tend to incorporate stocks in their retirement plans, rather than actively trade them.

Despite this, certain stocks can be highly volatile and short-term trades could be more sensible than long-term investments.

The scope for CFDs is much more evident. CFDs exist to make speculations based on the price of the underlying asset, without having to own the asset outright.

Dividends

Some blue chip stocks that have been around for decades and have matured as businesses may offer dividend payments to shareholders. Dividend payments are applicable to long-term holders of the stocks and are made on a quarterly (or biannual) basis. CFDs do not offer dividend payments as they are not offering share ownership at all. Instead, the price of the CFDs are adjusted to reflect the dividends in dollar value and be in line with the stock and its returns.

Trading hours

Stock trading is only available while the stock exchange is open. Because of the limited working hours, trading volumes don’t often see huge swings during a single session.

CFD trading hours differ based on the asset class. CFDs on currency pairs or Forex trading is available 24/5.

Fees

The fees for stock trading may be charged as commissions per trade, as well as a monthly account maintenance fee. The fees are typically quite low – around 0.1% of the trade value.

Many stockbrokers also offer commission-free trading and fractional share ownership, which allows traders to enter the stock markets using a small amount of capital at hand.

CFD fees differ from stock fees and the use of leverage and margin also may reduce the commission burden on the trader. CFDs have spread markups, commissions and swaps. While physical stocks are charged with spreads as well, they do not pay swaps.

Leverage

Stock trading does not offer leverage. The price of a trade must be fully paid upfront, or the trade will not be executed.

CFDs, however, offer leverage, which is money borrowed from the broker to increase buying power at a fraction of the otherwise necessary capital.

Regulations

Stock trading takes place on highly regulated exchanges. The issuing companies are obligated to uphold transparency and governance guidelines. However, there are some stocks that are traded on OTC markets that are subject to less regulatory oversight.

CFD trading is not tightly regulated as the market is not centralized.

Taxation

Stocks are subject to capital gains and dividend taxes. When a stock is sold at a higher price, it needs to be reported as a capital gain. Capital gains are taxed at a rate up to 15%. Dividend income is taxed at the same rate as ordinary income – between 10 and 37%. Stock trading is subject to stamp duty.

CFDs are not subject to dividend taxes, as they pay no dividends. The income generated from CFD trading is taxed as capital gains. CFD trading is not subject to stamp duty.

CFD trading compared to stock trading

The core differences mentioned above can be summarized as follows:

CFD Trading	Stock Trading
Not available for US and Canadian residents	Available for US and Canadian residents
Allows for the use of leveraged positions	Full value of the position is paid upfront
No shareholder privileges	Shareholder privileges (voting rights)
Not subject to stamp duty	Subject to stamp duty
Trading available around the clock during workdays	Trading available only on exchange hours
Adjustments of position to offset dividends	Periodic dividend payments (if applicable)
Long and short positions available	Trading only on rising prices
Trade stocks, ETFs, commodities, forex, etc.	Trade stocks and ETFs

Example of CFD and stock trading

To paint a clearer picture of the difference between stock and CFD trades, let’s look at an example of two trades executed at the same price, for the same amount of shares.

If we assume that 100 shares at market price of Stock A is bought at $25.10 per share and sold at $30.10 per share, the profit from the two trades would be as follows:

	CFD Trade	Stock Trade
Stock price	$25.10	$25.10
Order	Buy at $25.10	Buy at $25.10
Order size	100 shares	100 shares
Capital required	$502 (20% margin)	$2510
Close price	Sell at $30.10	Sell at $30.10
Profit	$500 ($5 increase x 100 shares – $500)	$500 ($3010 – $2510 = $500)
	Assuming there are no commission charges	Assuming there are no commission charges

Main takeaways on CFDs vs stocks

Stocks and CFDs are different in many ways and serve different functions on the market. The core differences that can be identified between the two assets are:

• Stocks are long-term investments, while CFDs are geared towards short-term trading
• Stocks may pay dividends, while CFDs make price adjustments to offset changes caused by dividend payments
• Stocks do not offer leverage, while CFDs do
• Stocks are traded when the exchange is open, while CFDs can be traded on extended hours
• Stock trading on exchanges is highly regulated, while CFD trading is not as closely monitored
• Stocks are the underlying assets themselves, while the underlying asset for CFDs can be stocks, commodities, cryptocurrencies, forex, bonds, etc.

These core differences make stocks and CFDs fundamentally different and choosing between them is up to the trader’s strategy, appetite for risk and level of experience.

Due to the lax regulations surrounding CFDs, they have been banned from the US and Canadian markets altogether. CFDs allow traders to hold long/short positions on stocks, which can be costly, as stocks have limitless upside.

FAQs on CFDs vs stocks

Are CFDs more profitable than stocks?

CFDs give traders the ability to take large short term positions using leverage. What’s more, you can short sell or go long. While trading physical stocks need more initial investment. CFDs are more profitable when trading short term. Physical stocks are more profitable if you are investing long term as there are less fees.

How are CFDs different from stocks?

CFDs offer leverage, long and short positions and do not represent ownership of the issuing company. Stocks are geared toward long-term investments, while CFDs are used to profit from short-term price fluctuations. Tax handling and regulatory framework for stocks and CFDs is also different.

Are CFDs riskier than stocks?

Stock trading can only lead to losses if the share price declines and the maximum loss is equal to the size of the positions. CFDs, on the other hand, offer leverage and long/short positions, which can lead to losses substantially greater than the initial position.

Is CFD trading taxable?

CFD trading is taxed similarly to stock trading, but is exempt from stamp duty as ownership is not transferred during CFD trading. Dividend taxes do not apply to CFDs, as they pay no dividends. The gains from CFD trading are taxed as capital gains.