There’s a huge debate online about CFDs and stock trading which tends to go to the extremes and leads to an improper understand of each category and thus beginners tend to use them inefficiently. Because of that, we want to clear, once and for all, how a beginner should treat each category, what strong and weak points there are, and make you fully aware of the bad and good consequences.
The main difference between a stock CFD and an actual stock
The most important aspect any trader needs to understand is that when you are trading a CFD you do not own the underlying instrument. CFDs are leveraged products that follow the exact price movement as the base asset (or underlying instrument as it is usually called).
In the case of share trading, you are purchasing the actual underlying instrument and as a result, you have the physical ownership.
In the case of CFDs, you are trading on margin, which means your broker requires you to deposit just a certain percentage of the total value of the trade in order to open a position. If we talk about stock investments, you are purchasing the shares for the full amount owing either individually-held electronic funds or a margin loan.
When it is suitable to trade stock CFDs?
It is important to understand that stock trading with CFDs is useful when you are trying to profit from short-term price movements. Also, since the broker lends you money (because of the leverage) you are able to trade higher amounts, thus being helpful for those who do not afford to deposit large amounts of capital.
Alt text: CFD vs. stock investment
In terms of commission, CFDs have smaller fees and spreads, but you need to consider the overnight rollover swap, which can add up significantly if you plan to hold a CFD position open for longer periods of time.
If you buy actual stocks, the commission is generally higher, but it will apply just once when you will open the transaction. Buying physical shares is suitable when you plan to hold them for longer periods of time and as an actual owner of the stock, you will be eligible to receive dividends.
To conclude, CFD trading and stock investment have both strong and weak points, and the decision on which one to pick should be based on your objectives, available capital, level of understanding and experience.