Stocks trading remains the fashion among the retail and institutional investors. With the evolution of the financial markets, new instruments develop to offer even better opportunities. One of them is a CFD or the Contract for Difference. CFDs are quite often advocated as more advantageous than stocks. Is it true? We will find out.
The first thing is to consider the speculative nature of CFDs. The CFDs are derivatives, which means that the underlying asset is never owned by the trader. The Contract for Difference is the agreement between the trader and the broker to exchange the value of the asset up to the contract's maturity. Since CFDs prices are very volatile, it is possible to make money during short-term fluctuations.
Stocks, on the other hand, are not the best option for price speculation. Unlike CFDs, stocks allow profiting only from the rising price. The only way for stocks to capitalize on the falling prices is the short selling. The speculator tries to sell the shares that are usually borrowed from the broker. In such a way, the stock trader hopes to buy the shares back later on to make the profit. As you might have noticed, this operation is risky and complex. On the other hand, the advantage of CFDs is the ability to go both long and short with no short-selling rules.
We at this site would like to outline the second major benefit of trading CFDs - the leverage. This means that with a small investment it is possible to receive the credit line from the broker to finance much bigger positions. It is important to remember that the leverage can not only increase the profit potential, but also magnify the losses. This is why trading CFDs can be quite risky. As for stocks, there is no leverage available from the broker. In other words, to buy the shares of the particular company you will have to invest the full amount required for the purchase. There is a so-called linked loan that might be used as the leverage in stocks trading, but it is not flexible as the leverage used in the online CFD trading.
Next important factor is the versatility that CFDs offer the investor. CFDs are available for different kinds of assets, not only stocks. Therefore, the trader can speculate on the price of the indices, commodities, currencies, bonds etc.
On top of that, there are some tax benefits for CFDs traders. CFDs are free of Stamp Duty, which lowers the transaction costs significantly. CFD traders do not pay the Stamp Duty, because shares are not physically owned. This would not be the case with stocks.
Although CFDs traders do not enjoy the shareholder privileges such as the participation in the management board meetings, they still can earn dividends. This means that apart from price speculation, CFD traders are not deprived of the fixed income.
The Bottom Line
Overall, CFDs seem to be the more attractive way to go. However, it is still important to consider the risks connected with trading CFDs as the instrument.