You might already be aware that you can purchase physical stocks, wait for the price to increase, and sell later to claim profits. But did you know that you can also trade stocks as Contracts for Difference (CFDs) and profit even in falling markets by short selling stock CFDs?

Stock trading offers numerous benefits to traders. The shareholder and dividend privileges provided by some industry leaders can be attractive for many. However, direct share trading has limitations, primarily relying on profits from rising prices. Many traders seek short-term exposure to equities without owning stakes in companies.

Contracts for Differences, or CFDs, are a popular alternative, alongside options. CFDs allow traders to profit from short-term price fluctuations and gain significant leverage. Stock traders often focus on the long-term potential of the underlying company—regulatory compliance, market shares, financial performance, growth, etc. Thus, physical stocks are primarily an investment vehicle. Conversely, CFDs are more about short-term catalysts affecting stock prices.

Trading stocks and CFDs can both be part of a well-balanced portfolio, but they differ significantly. This guide explores the core principles of stocks and CFDs and highlights what traders should consider when choosing between the two.

Choosing Between Stocks and CFDs – Factors to Consider

Stocks and CFDs differ fundamentally in ownership, taxation, regulatory oversight, and the trading process. While stocks can be bought and sold for profit (buying low and selling high), CFDs allow for both long and short positions, enabling profit from both rising and falling markets. When purchasing physical stocks, you gain ownership of the asset. When trading stocks as CFDs, you do not own the asset; you are speculating on the price, making it possible to profit even in bear markets.

CFDs also offer leverage, boosting purchasing power with a fraction of the capital. Deciding which is right for you depends on your trading strategy and whether long-term perks of stock ownership matter to you. Short-term traders are less interested in dividends, as they rarely hold investments long enough to qualify for payments. While short-term trading is feasible for both stocks and CFDs, the benefits of stock ownership are less significant in the short term.

CFDs involve paying interest in the form of swaps to brokers providing leverage, making them less desirable for long-term investing. However, they are better than physical stocks for short-term trading.

Tradable Assets

Stock trading involves buying and selling equities, including stocks, exchange-traded funds, and real estate investment trusts. No other assets qualify as stock trading. CFDs cover a broader range of assets, including stocks, forex, indices, commodities, cryptocurrencies, etc.

Profit & Loss

The maximum upside for stock trades is limitless, while the downside is limited to the value of the position. This is not the case for CFD trades. CFDs offer leverage and long/short positions, leading to highly risky trades with limitless downside. These features might deter risk-averse traders from incorporating CFDs into their strategy. Entering a short position using CFDs can be disastrous if the stock price keeps rising, as there is no price ceiling for stocks. Trading with leverage can lead to losses greater than your account balance, so ensure your broker offers negative balance protection before trading CFDs.

Scope

Stocks are typically long-term investments. Buying shares in a newly listed company or startup comes with promises of future profitability, innovation, etc., making stocks a common choice for retirement plans rather than active trading. However, certain stocks can be highly volatile, making short-term trades sensible.

CFDs exist for speculation based on the price of the underlying asset without owning the asset outright.

Dividends

Blue-chip stocks might offer dividend payments to long-term holders. These payments are made quarterly or biannually. CFDs do not provide dividends since they do not represent ownership. Instead, CFD prices are adjusted to reflect dividends in dollar value, aligning with the stock’s returns.

Trading Hours

Stock trading is available only during stock exchange hours, resulting in limited trading volumes during a single session. CFD trading hours vary based on the asset class. For example, CFDs on currency pairs (Forex trading) are available 24/5.

Fees

Stock trading fees include commissions per trade and monthly account maintenance fees, typically around 0.1% of the trade value. Some brokers offer commission-free trading and fractional shares, allowing traders to enter the stock market with minimal capital.

CFD fees include spread markups, commissions, and swaps. While physical stocks are also subject to spreads, they do not incur swaps.

Leverage

Stock trading does not offer leverage; the trade’s full price must be paid upfront. CFDs provide leverage, borrowing money from the broker to increase buying power with less capital.

Regulations

Stock trading occurs on highly regulated exchanges, with issuing companies adhering to transparency and governance guidelines. Some stocks traded on OTC markets have less regulatory oversight. CFD trading is less regulated due to the market’s decentralized nature.

Taxation

Stocks are subject to capital gains and dividend taxes. Selling a stock at a higher price than bought incurs capital gains tax, up to 15%. Dividend income is taxed as ordinary income (10-37%). Stock trading is also subject to stamp duty.

CFDs are not subject to dividend taxes, as they do not pay dividends. Income from CFD trading is taxed as capital gains and is not subject to stamp duty.

CFD Trading Compared to Stock Trading

The core differences between CFDs and stocks can be summarized as follows:

  • CFD Trading: Not available for US and Canadian residents, allows leveraged positions, no shareholder privileges, not subject to stamp duty, 24/5 trading, adjusts positions for dividends, long/short positions available, trades stocks, ETFs, commodities, forex, etc.
  • Stock Trading: Available for US and Canadian residents, requires full payment upfront, shareholder privileges (voting rights), subject to stamp duty, trades only during exchange hours, periodic dividend payments, trades only stocks and ETFs.

Example of CFD and Stock Trading

To illustrate, let’s compare two trades at the same price for the same amount of shares. Assume buying 100 shares of Stock A at $25.10 per share and selling at $30.10 per share.

Trade TypeCFD TradeStock Trade
Stock Price$25.10$25.10
OrderBuy at $25.10Buy at $25.10
Order Size100 shares100 shares
Capital Req.$502 (20% margin)$2510
Close PriceSell at $30.10Sell at $30.10
Profit$500 ($5 increase x 100)$500 ($3010 – $2510 = $500)
AssumptionsNo commission chargesNo commission charges

Main Takeaways on CFDs vs. Stocks

  • Stocks vs. CFDs: Stocks are long-term investments, while CFDs are for short-term trading.
  • Dividends: Stocks may pay dividends; CFDs adjust prices to reflect dividends.
  • Leverage: Stocks do not offer leverage; CFDs do.
  • Trading Hours: Stocks trade during exchange hours; CFDs have extended trading hours.
  • Regulation: Stock trading is highly regulated; CFD trading is less monitored.
  • Underlying Assets: Stocks are the assets themselves; CFDs can represent various assets, including stocks, commodities, cryptocurrencies, forex, and bonds.

These differences make stocks and CFDs fundamentally distinct. Choosing between them depends on your strategy, risk appetite, and experience level. Due to the less stringent regulations, CFDs are banned in the US and Canadian markets. CFDs allow holding long/short positions, which can be costly due to the limitless upside of stocks.

FAQs on CFDs vs. Stocks

Are CFDs more profitable than stocks?

CFDs can be more profitable for short-term trading due to leverage and the ability to short sell. Stocks may be more profitable for long-term investments due to fewer fees.

How are CFDs different from stocks?

CFDs offer leverage, long and short positions, and do not confer ownership. Stocks are geared toward long-term investments, while CFDs profit from short-term price fluctuations. Tax and regulatory frameworks differ.

Are CFDs riskier than stocks?

CFDs are riskier due to leverage and long/short positions, which can lead to losses exceeding the initial investment. Stock trading losses are limited to the value of the positions.

Is CFD trading taxable?

CFD trading is taxed as capital gains but is exempt from stamp duty. Dividend taxes do not apply to CFDs as they pay no dividends.