Investors and traders are continuously searching for vehicles that present the greatest opportunity to generate revenue by being participants in the financial markets. Of all the options available, trading stocks/shares and CFDs (Contracts for Difference) are two of the most widely chosen.

Each one has both benefits and drawbacks, and traders must do their research and go with a strategy that best suits their goals, risk tolerance, and trading style.

When it comes to financial derivative products, one of the most obvious differences between stocks and CFDs is that, unlike stocks, the CFD trader never really owns the underlying asset, in this case, the company’s shares.

We’ll go over the key benefits and drawbacks of trading stocks and CFDs to help you determine which is best for your trading strategy and style.

Let’s start by defining CFDs and discussing their differences.

Shares VS CFDs

Leverage and ownership are the two main ways that stocks and CFDs differ from one another. You become the owner of the shares when you purchase a stock. Investing in stocks is essentially acquiring a small ownership position in a business that you support. Each share of stock costs the full price when you purchase it.

A contract for difference is referred to as a CFD. You can speculate on a security’s price through online CFD trading even if you don’t own the underlying asset. A stock, stock index, money, or commodity may be the underlying security of a CFD. With CFDs, you can enter a trade with a smaller initial capital outlay because they trade on leverage.

The choice of an equity trader to trade stocks, CFDs, or both depends on their goals and unique set of circumstances. Prior to delving into the benefits and drawbacks, it is essential to comprehend the fundamentals of each trading strategy.

Stocks

Stocks are assets that signify a person’s ownership of a business.
Purchasing stocks in a company entails purchasing a share of that business, which allows you to speculate on its potential growth and success in the future.

Naturally, the value of a company’s shares increases as its worth does. Stock traders and investors profit from both the appreciation of stock prices and the quarterly dividends that these same companies pay to their shareholders.

CFDs

On the contrary, CFDs are derivative products that let traders speculate on financial markets like equities, forex, commodities and more without actually holding the underlying asset. CFD traders speculate on whether an asset’s price will increase or decrease in the future rather than making a direct investment in the company.

A CFD is basically an agreement between a trader and a broker to exchange the difference in an asset’s price between the contract’s opening and closing dates.

Let’s quickly review the key advantages and disadvantages of both stock and CFD trading.

Shares trading & CFDs: Similarities

Share price exposure:

Stock CFDs and share trading give traders the opportunity to speculate on changes in the stock market. They can profit from the rising and falling prices of underlying financial assets by using a Contract for Difference (CFD). A stock also makes it possible for traders to profit from changes in share price.

Risk involved:

Whether trading stocks or CFDs, there is the possibility of losing money. Come up with your own research; keep in mind that prices are subject to change; and never trade more than you can afford to lose.

Liquidity:

Since both stocks and CFDs are relatively liquid, buying and selling them is generally simple.

Availability:

Share trading and CFDs are available to traders worldwide.

Shares trading & CFDs: Differences

Financial instrument type:

CFDs are derivative instruments, but share trading requires ownership of the underlying stocks.

Ability to go short:

Trading CFDs allows speculating on a declining price trend by starting a short position, whereas share trading only allows going long.

Leverage:

Traders may create larger positions with a lower initial investment because CFDs permit the use of leverage. Remember that using leverage may generate both profits and losses.

After-hours trading:

You are limited to trading stocks during the hours that the relevant exchange is open. CFD Brokers differ in terms of their availability for CFD trading after regular business hours.

Available markets:

CFDs offer access to a much greater variety of asset classes than share trading does. You can trade indices, commodities, forex and more with CFDs.

Is trading stocks less risky than trading CFDs?

Because price movements in the market you trade will account for a higher proportion of the margin deposited compared to if you paid the whole amount, using leverage increases the risk involved.

For instance, if you put down 10% as collateral for an equity trade, all it takes is a 10% decline in the share price for you to lose your whole deposit. But if additional money is added wisely, it can always be used to cover margin calls, giving some flexibility. Extra risk may arise in certain situations where the losses on a trade exceed the money deposited for margin.

Is trading CFDs more affordable than trading stocks?

The cost of trading CFDs consists of the spread, an overnight funding fee, and, in some cases, a commission. Stock trading involves the spread paid to the stock exchange, possession fees and occasionally a commission, whereas overnight funding charges are not.

Quite recently, commission-free trading has brought the cost of trading stocks closer to that of trading stock CFDs. What influences cost is the anticipated holding period for the trade.

Market volatility’s impact on stocks and CFDs

Market volatility may significantly impact both trading stocks and CFDs. With the latter, the difference in price between the contract’s opening and closing prices determines the profit or loss. This means that in an erratic market, this difference can be significant.

Market turbulence in stocks can cause share prices to change, which can influence investors’ dividends and the return on their investment in total.

How does leverage differ between stock and CFD trading?

Leverage in CFD trading enables traders to open bigger positions with a smaller initial amount. This could result in higher profits, but it could also result in higher losses if the market turns in the opposite direction. On the other hand, leverage is rarely used in stock trading. When you purchase stock, you pay the entire amount up front. Therefore, your potential profits are reduced even though your potential losses are set at the price you paid for the stock.

In trading, leverage is a two-edged sword. By borrowing money from their broker, traders can increase the amount of risk they take on when the market fluctuates. Leverage can be significantly higher in CFD trading than it is in traditional stock trading. For instance, when trading CFDs, a leverage ratio of 50:1 indicates that you can trade $50 worth of assets for every $1 in your account.

Final thoughts

Choosing the instrument that best suits your risk appetite and trading goals is ultimately yours. Although CFDs can provide you with low initial costs and access to a wider spectrum of markets, there is a risk associated with using leverage.

However, owning shares has unique benefits, like the ability to take part in business decisions and the possibility of receiving dividend payments. Always conduct your own research before choosing which products to include in your trading portfolio.