Stock trading has retained its appeal for new and experienced investors alike. Like all investments, trading involves some form of risk, stocks can be traded easily and lucratively once you understand how they work. Investing in stocks also offers a sense of ownership that comes with certain benefits for shareholders. Stock CFDs or CFDs in general, however, have certain advantages over stocks that are also worth exploring.
Stock vs Stock CFD: Definition and Comparison
What is a Stock?
We’ve recently defined stocks in our ‘ETF vs Stock: What’s the Difference?’ article, so there’s no reason to go into it too deeply. But in sum, a stock is simply a form of equity broken down into shares, each of which represents your ownership in a company. For example, anyone who owns shares of Apple is technically a part-owner of the tech giant. How much of that company you own depends on how many shares you’ve purchased and currently hold.
What is a Stock CFD?
On the other hand, a contract for difference (CFD) is a derivative product. In finance, a derivative is a contract that derives its value from the performance of an underlying entity or asset. The key difference between stock and contract for difference is explained in a guide to CFD trading by Plus500. In buying and selling CFD positions, there is no need to own the underlying asset. This means that you can’t go around boasting that you own shares of a company like Apple Inc., because a CFD doesn’t afford you that right. Instead, what you have is an agreement between yourself and a CFD provider, wherein you make predictions regarding how the value of the underlying asset (such as shares of stocks) changes over time. An increase or decrease within this period will result in gains or losses for a CFD holder.
Unlike stock trading, which looks at buying and selling prices, signing a CFD involves an entry price and an exit price. The entry price is the value of the underlying asset at the time the contract is signed, while the exit price is the estimated value of the underlying asset in the future.
In CFD trading, you can take two positions: the long position and the short position. A long position predicts that the value of the underlying asset will increase, which is indicated by a higher exit price and a lower entry price. In this case, the CFD provider will pay the difference. If the opposite happens, then the investor would have to pay the difference.
Conversely, short positions predict that the value of the underlying asset will decrease, so you’re betting against it. As a result, the exit price is lower than the entry price. If the value decreases, the CFD provider pays the difference. However, if the value increases, the investor pays the difference. Loss or gain depends on the asset’s price action in relation to the contract.
Stock vs. Stock CFD: Pros and Cons
Unlike stock trading, CFDs come with leverage. This essentially means that the CFD provider can give you more capital than is currently in your trading account so you have more to trade with. However, this also means bigger losses when your speculations about the market go wrong.
The long and short positions are also lacking in stock trading. The Street’s feature on common investing mistakes points out that stock traders often become overzealous and believe that a company’s value will not decrease — especially if it’s currently doing well. Trading CFDs, however, allows you to take an alternative position, while also giving you access to a wider range of markets on top of stocks, like forex, commodities, and bonds.
However, FX Street’s list of common errors CFD traders highlights how research-intensive it truly is. Other than making market predictions, you also have to calculate the risks involved in trading CFDs, especially if you’re using leverage, which tends to magnify your gains and losses. This means that trading CFDs is not ideal for new investors, as it requires a lot more work than stock trading.