CFD versus Stock Trading: Here are the Pros and Cons

Finance | February 12, 2020, Wednesday // 17:20|  views

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Investing in the financial markets is as exciting as it is risky. While some have made astonishing fortunes over the years, not everyone is as fortunate in their forays. The difference often boils down to the choice of investment and how well you understand it.

Finding the right investment is vital in keeping a profitable portfolio. Without figuring out the details first, it is possible to incur massive losses.

So, are you split between CFD stock trading vs direct stock trading? This article focuses on this topic and looks at the distinction between the two.

CFDs are a unique derivative product that gives you additional options in investing. A Contract for Difference is a chance to make money off the settlement differences in a futures contract. In a nutshell, the trader contracts with a broker, speculating on the price of an underlying asset moving in either direction.

The long or short CFD positions have an entry price when entering a trade and exit price. Should they make the right call by the time of exiting the contract, they make money and vice versa. Through it all, you don’t necessarily need to own the underlying asset.

In contrast, purchasing stocks means that you own the stock until you decide to sell. For CFDs, the contract ends, and the chips fall as per the situation at the exit point. Therefore, ownership is a fundamental difference between stocks and stock CFDs.

Traditional Stocks versus CFDs

Conservative investors will always prefer owning physical stocks. The alternative of CFD trading is still catching on and presents a unique opportunity.

Purchasing CFD stocks from a broker gives you exposure to that market or asset without holding the underlying stock/asset. CFDs are a derivative product, while stocks represent physical ownership.

Instead, a trader tracks the price movement of the underlying financial instrument, hoping to make the right up or down prognosis. Therefore, it is befitting to analyze the benefits of CFD trading and weigh them up against the merits of traditional stocks.

Pros

Here are some advantages that you can capitalize on when trading CFDs:

  1. CFD trading typically includes leverage and margin. Leverage means that you don’t need to have the full trade amount to execute a trade. A trader can magnify their capital depending on the terms of the contract. Margin, on the other hand, means that if you have a 50% margin, for instance, you only need 50% of the trade amount to execute a trade. Such features magnify the impact of your capital in CFD trading. Such cash flexibility is not typical in stock trading.

  2. Tax considerations are also a factor in CFD trading. In the USA, CFDs fall under the class of swap contracts with ordinary capital gains or capital losses determining taxes. For UK law, a trader can use losses to offset against profits for tax purposes without stamp duty.

  3. You can use CFDs to hedge against traditional stock holdings. Remember, CFD trading is bi-directional and can be profitable even in falling markets. With leverage, you can use a smaller amount of capital to hedge against stock slides.

  4. CFD trading provides exposure to a broader range of assets, including commodities, currency pairs, and bonds. Stocks are more specific. With a suitable broker, you can execute your desired CFD trades at a lower cost at any time. Restrictions as to day trading, that affect stocks trading don’t restrict CFDs. The broader range of financial instruments provides traders with useful versatility in the market.

Cons

  1. Since a trader does not own the underlying asset, CFD trading comes with significantly higher risk. In fact, most traders who touch CFDs end up on the losing end. It needs careful analysis to have the possibility of engaging in this field profitably.

  2. CFDs are still an outlier investment option for the most part. Most people in financial markets prefer stocks because of their historical reliability. This market is still growing and will attract further regulatory scrutiny.

  3. Leverage, though profitable if used well, can be flattering to naïve investors. Part of the reason why so many people lose money in CFDs is a poor understanding of leverage. High leverage does not guarantee high returns unless, of course, the investment works out.

Final Thoughts

In the grand scheme of things, CFDs have a unique and essential role in financial markets. When used well, they are a useful tool for two reasons.

You can either trade CFDs exclusively and profit off rising and falling markets or use them to hedge against stocks or other underlying assets.

However, the risk factor in trading CFDs is apparent, and you should not overlook this aspect when starting your investment journey.

Many inexperienced traders would fare better trading blue-chip stocks. Regardless, those that feel informed enough and competent to undertake CFD trading can maintain a profitable ledger. Both investment options can be lucrative, but it is vital to pick the right one for your style and level of trading.

 

 


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