Buying shares vs. Trading CFDs: what is the difference?

wayne

When it comes to buying shares, you are either an investor or a speculator. An investor holds a piece of stock for the long term while a speculator capitalises on short term volatility.

Both the investors and the speculators aim to make money depending on the accuracy of their predictions.

As Warren Buffet, the world-renowned value investor puts it, investing is a long term game. When you invest in a piece of common stock, you are investing in the issuing company. Consequently, your eyes should be on the fundamentals of the company, including its long term growth plan.

However, in speculation, your focus is the short-term price movements resulting from the forces of demand and supply. Speculators can try to make money in both the rising and falling markets depending on their strategy.

How to speculate on shares

You can speculate on shares by buying low and selling high or through what is known as short-selling. In short selling, the speculator borrows the stock they believe will decline in price from the broker and sells it at the current rate. They then have to wait for the prices to go down after which they repurchase the stock and return it to the broker, pocketing the difference. A trader experiences losses in short-selling if the share price goes against their prediction.

You can also speculate on shares through a derivative product known as a Contract for Difference (CFD). In general, CFDs trading involves speculating on the price movements without owning the underlying asset.

You can trade CFDs online with CFD brokers like capex.com. Most online brokers offer CFDs on multiple products such as shares, currencies, indices, and commodities.

What are CFDs on Shares?

When you buy a share CFD, you enter into a contract with the broker to capitalize on market trends by predicting the price of the underlying stock.

If the prediction is correct, you cash in the difference; if it is wrong, you lose money for each point that the market moves against your prediction. You can also short-sell stock CFDs by borrowing the CFDs from a broker, selling them high and then buying them low when the price goes down.

The best thing with CFDs on shares is that you can speculate on both rising and falling markets. Moreover, they do not require you to pay stamp duty since you do not own the underlying asset.

Also worth noting, stock-CFDs trade on margin, which means that you can open a larger position than what your capital allows. Margin trading provides both an opportunity and risk in that you make magnified profits if the market moves in your favor and huge losses if it goes against your prediction.

Advantages of trading shares through CFDs

Traditionally, you can trade stocks on margin, but the leverage is small, and your broker must hold a portion of your securities as collateral. The CFDs, on the other hand, are highly leveraged, and there is no collateral requirement given that you do not own the underlying asset.

Normally, one CFD is usually equivalent to one share, but the CFD issuer only requires you to deposit 20% of the contract value. For instance, when you buy 1000 XYZ CFDs at $10 each and a margin of 20%, you only need to deposit $2000 instead of 10,000. As mentioned earlier, trading on margin can translate to high profitability but can also result in magnified losses.

Another advantage of trading share CFDs is that they are cheaper than trading the real asset. Firstly, stock CFDs traders do not pay stamp duty since they do not own the underlying asset. Secondly, there are no commissions since the broker earns a quoted spread. The spreads charged by the broker can either be fixed or floating.

CFDs are also easily accessible when compared to traditional stock buying. Anyone, anywhere across the globe can trade stock CFDs with a capital investment as little as $100. With CFDs, traders can easily access leading stocks such as Facebook, Microsoft, Google, Amazon, and Netflix. You need to sign up with a broker and deposit the minimum amount to start trading.

Bottom line

While stock CFDs provide a myriad of opportunities, they are not without risk. As mentioned earlier, they are highly leveraged, which means that a small negative market movement can result in enormous losses.

Moreover, CFDs are not as tightly regulated as other financial instruments. What this means is that the likelihood of getting scammed is high. That’s why it’s important to choose a broker that is regulated by a respected regulatory body like the Cyprus Securities and Exchange Commission.

Furthermore, holding CFDs for long may result in huge costs given that there is a charge for holding them overnight.

If you are planning to trade CFDs, we recommend that you invest in education and conduct enough due diligence before opening an account with a broker.

Next Post

Hero MotoCorp inaugurates first-ever training centre for women at Ambala

Hero MotoCorp Ltd on Saturday said it has inaugurated the first-ever training centre for women at Industrial Training Institute (ITI) at Ambala in Haryana. The Centre of Excellence for Women – at ITI Ambala in Haryana will build key skill-set amongst women. […]

Subscribe Now