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CFDs Vs Stocks
CFDs vs. stocks. Who wins and how exactly do things stack up?
In the financial markets, there is a plethora of financial products that can be traded. Given the right conditions, trading each one of the products can have the potential to create trading opportunities.
But in the world of wonderful choices, it is crucial to focus on the wheat from the chaff, and tune out the noise. In this guide, we go through some of the main differences between stocks and CFDs.
- 🆚 Glance: CFDs Vs Stocks
- 🆚 Deeper Historical Context
- 🆚 Quick Definitions
- 🆚 Similarities & Differences
- 🆚 What Investment Should I Focus On
- 🆚 FAQs
Glance: CFDs Vs Stocks 📉
A quick disclaimer: we provide summaries of properly requested topics. Our guides are not definitive, a run offering financial advice. We provide you with Mission-critical data efficiently. This will drop to do your research and relate your own circumstances. Below are some of the key characteristics of contracts for differences, and those for stocks – a quick glance.
Contracts for Differences Characteristics
- ✔️ Professional traders. You really trade professionally and you have a sophisticated strategy and systematisation that is able to adjust to different market situations.
- ✔️ Lack of commitment. While the ability to jump in and out of the markets nimbly.
- ✔️ Access. You want a vehicle that gives you access to as many markets as possible, for instance, commodity, forex, stocks, and options).
- ✔️ Dividends/ownership isn’t important. It does make a difference whether you are the underlying assets or can gain dividends.
Stock Trading Characteristics
- ✔️ Nonprofessional. You how an understanding of the markets but do not actually professionally trade in them.
- ✔️ More commitment. You have a certain affinity to the companies you invest in, you want to invest long-term.
- ✔️ Direct market access. You want to directly work in various markets.
- ✔️ Dividends/ownership is important. You want to have an ownership stake in a company and be able to gain dividends.
|Flexible trading style||Can support any style of trading, including scalping, day-trading, and swing trading.||Best suited for swing traders and investors seeking ownership of shares.|
|Characteristics||Typically involve borrowing money to make trades (taking out loans)||Shares are issued by your broker, paid by money in your account|
|Transaction costs||Spreads/swaps||Brokerage fees|
|Leveraged product||Yes||Only available on margin accounts|
|Derivatives||Derivatives on the underlying asset||Not a derivative|
Deeper Historical Context 🏛️: Stocks vs CFDs
Context is a helpful aid when trying to understand some of the central differences between contracts for differences and stocks.
The stock market has been one of the most influential ways for businesses to raise capital and sell shares of their company, a speculative form of trading that has been both for the social better and worse. The stock market is a way to invest in companies you believe will perform well over time.
And any form of trading is based on the perception of value. In order to better understand the difference between CFDs and stocks, it’s useful to look into the history of both…
1603-1700 – Origins of the Stock Market 🔔
The earliest form of the stock market was in the Dutch Republic in the 17th century.
Back then, the main financial instrument for raising money for companies to build trading ships and other commodities was through the sale of what were called “shares.” These shares were a percentage of the profits from the company, which paid dividends to the shareholders.
The first recorded example of this was in 1609, when the Dutch East India Company raised money through the sale of shares. The shares of the Dutch East India Company soared in value, making a lot of people rich very quickly.
The main reason for this is that the Dutch East India Company was building an East Indies trading empire at the time. With the company being so profitable, its stock price soared, and investors made a lot of money when they sold their shares in the company.
Ever since, the stock market has been a way to invest in companies. Investors hope their share prices will rise over time, so they can sell them at a profit. A few key events along the way:
📖 1773-1819 – The London Stock Exchange
- We need to take it back to the invention of steam engines. The LSE was officially founded in 1773 during the Industrial Revolution. The Industrial Revolution was the period of time when people began to use steam power and machines to make a lot of goods. With the country focused on industry, the London Stock Exchange became the world’s biggest stock market.
- The Industrial Revolution created new companies, especially in the steel industry, that were looking for investors. With so many people hoping to invest in these companies, the London Stock Exchange grew to become the world’s largest stock market.
- Up until 1819, the London Stock Exchange was an open-outcry trading floor, meaning people gathered together in one place to trade. While this was a very efficient way to buy and sell a stock, it was also very chaotic and risky.
- In 1819, the LSE created the first physical trading floor for buying and selling shares. This trading floor was called the “open outcry” trading floor, and it created an orderly system for buying and selling shares.
In short, the LSE was founded at a time when London was leading the way in an industrial (productive revolution) that included the steam engine, massive productivity in steel, and mass production power.
📖 1900s-1920 – New York Stock Exchange
- Productivity increased into the wild days of the 1920s, particularly when the US experienced a boom and its own industrial revolution. In the early 1900s, people started investing in the stock market with a lot of enthusiasm. The stock market boomed and attracted a lot of investors by the 1920s.
- Notable companies like General Electric and the Ford Motor Company were listed on the New York Stock Exchange. Many people also invested in smaller companies that they believed would do well.
- The public bought stocks in massive amounts, and people began trading stocks in big numbers. The stock market by this time had become an organized and regulated system, with a centralized exchange, the New York Stock Exchange, and an established network for trading stocks.
- Stock exchanges were like a marketplace where companies could list and sell their shares for investors to buy. American banks were also heavily involved in the stock market. They would often use the money they had on hand to buy stocks, which created a system where banks were heavily invested in the market.
📖 1990s – The Origins of Contracts for Differences
CFDs, however, were born in a very different world and age.
- Rather than the natural way of participating in an intense period of productivity and physical trading of hard goods, CFDs were born as a way of hedging against volatile stocks without needing to actually own stocks.
- CFDs were developed by the British in the 1990s. Its inventors were Brian Keelan and John Wood. Both were employees of UBS Warburg, which was a multinational Swiss investment bank. Purportedly, the first transaction using this vehicle happened as part of the Trafalgar House Deal — these were used to swap equity on the margin.
- This ability wasn’t instantly offered to retail traders. Instead, it was used as a hedging feature by institutional managers and hedge funds in order to safeguard stock portfolios. They harnessed the power of marginal trading offered by CFD.
- Another advantage offered by this vehicle, at the time and up to now, was the lack of needing to own underlying assets. Because there was no purchase of shares, traders were exempted from needing to pay stamp duty in Britain.
This saw lots of traders taking advantage of the capabilities of the CFD product — everything from hedging and margins to leveraged and lack of stamp duties. Slowly, it garnered more popular attention.
Performance During Crashes: Stocks vs CFDs
Let’s look into this as a way of understanding the innate weaknesses of stocks vs CFDs…
📖 1929-1939 – Stock Market Crash
- The market crashed in 1929 lasting until 1939. This Great Depression era was a dark time for the stock market. During this time, banks and investors went bankrupt, losing a lot of money. The stock market also lost a lot of value because companies were going out of business and their shares were worth less.
- The stock market was closed during the Great Depression, and it didn’t reopen until 1934. (If you wonder if this could happen again, we’re ahead of you…that’s why Australian farmland, culture and families are such powerful investments. But more on that later.)
- When it did reopen, it was a different place than it was in the 1910s and 1920s. The Securities and Exchange Commission, or SEC, was created in 1934. The SEC is America’s regulatory agency that oversees the stock market and all the companies listed on it. The SEC has the power to investigate fraud and other illegal actions in the stock market.
📖 1984-Today – Rebuilding Confidence in the Markets
- As the markets rebounded, people began trading stocks again, and the market grew. The markets grew to become very large, with billions of dollars being traded and invested by people every day.
- From a low of around $6 trillion dollars in the early 1980s, the total value of all the companies listed on stock exchanges grew to become more than $64 trillion dollars by 2007. However, the stock market bubble burst again in 2008 when the housing market crashed. Investors lost a lot of confidence in the stock market and didn’t feel like investing in the markets anymore.
- The markets became very cheap, and many companies were selling shares for very low prices. This created a big opportunity for investors, especially for new investors looking to get started in the markets and build their portfolios.
What Does This Mean For CFDs vs Stocks Today…?
Trading is the backbone of finance. Today, we have many of the same warning signs that a Great Depression is underway, particularly for western nations. Countries like the US, UK and Germany which were once very productive are now heavily in debt and low in resources necessary for power and electricity.
This wider context should make it clear that financial vehicles are only as strong as the economy underpinning them. With that context, let’s continue our comparison of CFDs vs stocks.
Quick Definitions 📗: CFDs vs Stocks
So What Are Stocks?
A stock is a share in a company. Owners of these shares are called shareholders. When you invest in stocks, you’re betting on the company. The companies that issue stocks are called issuers. If you own a piece of a company, it’s called equity ownership or stock ownership.
If you own one share in Apple Inc., you own a small piece of Apple Inc. Owners of these shares are called shareholders. When you invest in stocks, you’re betting on the company. The companies that issue stocks are called issuers. If you own a piece of a company, it’s called equity ownership or stock ownership.
So when you buy stocks, you buy ownership in a company and may receive dividends, which are pieces of the company’s profits for each year. The company might be a large publicly traded company like Apple Inc. or it might be a small privately held company.
How to Buy Stocks
These days, the typical way to invest in stocks is through online brokerage accounts. Through online trading and buying and selling securities, you can quickly access market prices and place trades whenever you want. But this isn’t as easy as it sounds. So what are stocks and why should you care?
You can buy stocks via a broker, like eToro, TD Ameritrade, or IG. You can also invest in stocks yourself and form your own brokerage account. This is called a self-directed account. However, because stocks can be more complicated than other types of investments, it’s best to get help from a financial advisor.
And What Are CFDs?
Meanwhile, contracts for differences are type of financial derivatives trading. There was no purchase or delivery of underlying goods or physical securities. Instead, differences between opening and closing trades are settled in cash. Because of the use of leverage, it’s considered an advanced trading strategy. You can buy CFDs pretty much the same way as stocks, although there is:
- Less regulation which has led to some scandals such as Plus500 allegedly manipulating their orders in order to prevent customers from successfully claiming their profits (to a degree, providers may have a massive advantage in being able to see their hand as well as yours and to time things to their benefit)
- Lower liquidity (it may take longer to buy and sell), which can leave you stranded including fewer protections from financial insurance agencies
- The use of debt (leverage), which amplifies the magnitude of each order.
Similarities & Differences 📕: CFDs vs Stocks
We’ve reviewed their histories, gone through their separate characteristics. Now, let’s review CFDs vs stocks by comparing them side-by-side.
1. You Can Take Advantage of Price Movements with Both
Indeed, this is the one central similarity between the two and the other characteristics are differences, no pun intended. Both stocks and Contracts for Differences let traders take advantage of the rise and fall of underlying financial assets. Although you have to specifically short-sell so in order to take advantage of falling prices via stock trading.
CFDs naturally let you make money in either direction.
2. No PDT Rule Applies to CFDs
Which increases flexibility. Whether you scalp, day-trade or do swing dealing, whatever pattern you use or length that you keep your positions open, CFDs let you use them to support your investment strategy and trading style.
By comparison, stocks have more restrictions. Whether or not you can do day-trading, will depend on the jurisdictions of your broker. While regulations certainly apply to CFDs as well (for instance, is not allowed in northern America), Australians are able to avoid Pattern Daytrading (PDT) rules that would otherwise apply to a stock margin account.
3. CFDs Let YOu Short-sell
We mentioned this above. Because you are not purchasing the underlying asset, you are not bound directly to the equity of their assets. Whether Amazon stock falls or grows in value, what matters is the direction that you bid on its movement.
By comparison, shareholders are always going long.
If a stock trader wants to short their stock, they will need to bore shares from a broker. The trader then sells these in order to repurchase at a later date for a lower fee in order to take advantage of the depreciating market. But be boring can be tricky, particularly for stocks that are thinly traded. However, there are also liquidity issues when dealing with the CFD.
Too short, it is necessary to borrow shares from your broker. “Naked shorting” is the act of selling short without initially borrowing stock, or at least making sure that it can be bought. This is illegal because it could theoretically lead to a situation where you cannot deliver.
CFDs will charge you a variety of transaction costs, including the spread, fixed ticket, and more. There is also a commission for accessing the market, according to your account type and broker. You can also incur overnight fees. Some of these overlap with stocks.
5. CFDs Often Use Leverage
CFDs commonly use leveraged, which means that you are taking out a loan in order to trade. Only a portion of the money in the trade is your one way, the rest is borrowed from your broker — that’s why it’s called trading on the margin. You’re getting exposure to the market but you put all your fraction of the full capital up.
In this instance, it is essential that you use negative balance protection features, which limit how much money you can lose to the total amount of money in your account. Otherwise, you could lose a lot more money than you actually even have in your bank account.
Many short-term traders use leverage, in order to make larger returns on small price movements.
By comparison, stock trading is divided into two types of accounts: cash accounts and margin accounts. The former lets you trade normally, only using the money that you actually have. Whereas a margin account lets you borrow cash from the broker. The broker has its own securities that it uses as collateral. Before they issue you the loan, you have to meet certain requirements, which changes according to the broker.
6. CFDs are Derivatives
Derivatives are not the same as underlying assets. When you use a CFD, you are speculating, from a distance, on the movements of these assets. Because you do not need direct market exposure to these products, using a CFD typically gives you broader access to markets, for instance, precious metals, options, commodities and stocks. But the price of your CFD is largely based on the value of their asset in the real market.
Once your contract clauses, the broker and trader settle the difference in cash, minus any fees. And an investor has a profit or loss according to whether they guest in the right direction and to what degree.
But a stock is not a derivative product. It legally represents a proportion of the publicly traded company, and shareholders own a fraction of that company. The price of your stock, therefore, directly reflects the market value of the company.
CFDs vs Stocks: What Investment Should I Focus On?
Whatever you focus on the most intensely, frequently and for the longest time period becomes your biggest point of view. How you decide to use that is up to you of course. But many signs of the times suggest that the markets are at an unprecedented point of volatility. Relying on either may not be enough to weather the storms but they can support a bigger mission.
CFDs vs Stocks 📙: FAQs
What are the Risks of CFDs vs Stocks?
Shareholders have the risk of their stop falling in price and their long-term commitment leading to a loss on investment. This is an unavoidable aspect of life and in trading.
Using a CFD has a similar amount of risk but it can be much more intense if you use leverage — there’s also a counterparty risk of the firm you are using to trade becoming bankrupt. Providers of the CFD product are under less regulatory scrutiny and may have a different level of liquidity compared to direct market access of stocks.
What is the Tax Treatment of CFDs vs Stocks?
It is very possible that your CFD product incurs fewer sum fees than directly trading stocks, but you will need to check according to your broker and the terms and conditions.
What is the Leverage of CFDs vs Stocks?
CFDs naturally use leverage, up to a maximum cap. This means that you are able to trade more cash than you actually have in your account. Stock trading is not leveraged unless you apply for a margin account and borrow shares.
Who are the Different Investor Types for CFDs vs Stocks?
Many investors are limited to only purchasing stocks. For instance, pension funds are restricted to stock trading rather than using a CFD. It is also prohibited in some countries like the USA.
What is the Market Coverage for CFDs vs Stocks?
In general, CFD trading can cover a much broader range of markets than stocks. This is natural because stock trading is limited to the stock market. But CFD could be used to trade all kinds of things — commodities, forex, stocks, indexes, cryptocurrencies, and more.
How does Financing differ for CFDs vs Stocks?
You will find similar administrative fees for both products, depending on your trading style certain fees will be more important than others. For instance, day-traders typically want to avoid overnight fees.
The popularity of the CFD product comes down to its flexibility. It’s nimble and noncommittal in many ways. There was a surprising history of it being used by institutional investors and fund managers, in order to do hedging and equity swaps.
The CFD product is also very volatile. It requires sophistication and experience to not do serious destruction. However, holding stocks long-term can be cost-effective, with direct market access given advantages like dividends. You don’t get this with the CFD product.
While liquidity with the see of the product might be lower than trading stocks directly, with added counterparty and regulatory risks, some people use them for short-term trading — seeking to gain big returns from small price movements. This is common with scalping and day-trading.
See if the product naturally lets you do short-selling, which you can’t do with stocks out why. Overall, both of these products allow you to take advantage of movements in the financial markets and which one is suitable for you will depend on your level of experience.
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