There are many different ways for you to bolster your portfolio with investments. Two popular methods to do so are stocks and CFDs.
Though you may be asking yourself: CFD vs stocks, which is the better investment? Well, my guide will tell you everything you need to know about the differences between the two so you can decide which would best suit your investment strategy.
Also consider: My guide on how to trade CFDs
- The main difference between CFDs and stocks is that CFDs are a form of “betting” on how a company will perform, while stocks are assets directly tied to a company’s value.
- Traditional share trading allows you to purchase a piece of a company, while CFDs only let you speculate on the underlying asset without owning it.
- CFDs are typically opened and closed within a week, while stocks are usually held for longer periods, often for many years.
- When you try stock trading, you are required to invest the full amount of money to purchase a stock. Meanwhile, you can trade CFDs using leverage, meaning you don’t need the full investment amount upfront to invest.
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What are CFDs?
CFDs (standing for “contracts for difference”) are a form of investment derivative that involve making predictions on the movement of a particular asset.
When you trade CFDs, you are entering into an agreement with your CFD broker to exchange the difference in value for an asset from when the contract opens, to when it closes.
You are only place orders on the underlying asset rather than purchasing it for ownership when you trade CFDs.
One very important aspect of CFDs is leverage. This allows investors to purchase larger CFD positions for less than the full value.
Say your CFD broker offered you leverage of 5:1. If you wanted to open 100 contracts at £130 for each contract, your total cost would be £13,000.
With a 5:1 leverage, the margin, which is the initial payment investors must make, would be 20%, meaning you would only be required to pay £2,600 upfront.
Of course, while this leverage helps you open contracts you normally wouldn’t be able to afford, this is a double-edged sword. Losses and gains are both magnified with leverage, so you could end up losing more than your initial investment.
How do CFDs work?
When you trade CFDs, you will open a position that predicts how a certain company’s share value will move.
For example, say you wanted to purchase CFDs for Apple. If you predicted that Apple would rise in value, also known as “going long”, you could purchase 100 CFDs. If Apple’s share price at the time was £160, the total value of the CFD purchase would be £16,000.
Then, if your broker offered leverage of 5:1, you would only be required to meet the margin, which in this instance would be 20% of £16,000, which is £3,200.
Now that you hold your long CFDs, you will be hoping that the value of Apple increases. If the value appreciated to £170 a share, you would make the difference between the opening and closing share value, which in this case is £10.
This £10 would be multiplied by the number of contracts you opened. So, you would make £1,000 profit from the above example.
Conversely, if shares fell to £150, you would lose £1,000, as the difference between the opening and closing price is -£10 multiplied by your 100 contracts.
There is an easy way to figure out how much profit, or indeed loss, you will make from a CFD trade. Simply multiply the number of CFDs you hold with the closing price minus the opening price.
It’s worth keeping in mind that while you may not have to pay Stamp Duty when CFD trading, you typically will pay Capital Gains Tax (CGT) on any profits made.
How do you invest in CFDs?
First things first, you need to ensure that your broker offers access to CFD trading. Not all brokers do, so you should research which ones offer access to the CFDs you wish to trade.
Next, you should think about adding funds to your CFD trading account. It’s worth keeping in mind that you are unlikely to earn interest on any uninvested money held in your trading account. So, you may only want to deposit the money you plan on investing.
Now you’re ready to start CFD trading. You should first choose which market you want to purchase some CFDs in, which you can read more about further in my guide.
Then you should decide whether you want to open a short position, in which you predict the value of the underlying asset will drop, or a long position, where you predict the value will rise.
You can then input the number of contracts you wish to open and make the purchase.
At this stage, you should also consider setting stops and limits on your contracts. These will automatically execute a trade if the value of the underlying asset reaches a specific value. This can stop you from losing money rapidly if things don’t go your way and you aren’t able to react quickly enough.
What can you invest in with CFDs?
Several different markets allow CFD trading. This includes:
Before you start CFD trading, it may be worth checking the range of CFDs your broker offers. For example, some may only allow trading of stock CFDs, while others may offer commodity or forex CFDs.
When can you invest in CFDs?
Since there is such a wide range of financial markets available for CFD trading, the trading hours are completely different when compared to traditional investing.
In fact, you can typically trade 24 hours a day, every day, when you invest in CFDs.
Of course, this doesn’t mean you can trade every CFD at any hour of the day, as there are varying stock exchange opening hours. For example, trading stock CFDs must be done when markets are open.
But since you have access to so many markets, you could theoretically trade at any time.
CFDs and risk
Before you start trading CFDs, you must fully understand the risks involved with doing so. In fact, these are such complex instruments that more than half of retail investor accounts lose money when trading CFDs.
It’s important to note that CFDs present a high risk of losing money rapidly due to leverage. While you will gain exposure to potentially greater gains with leverage, this works inversely too.
Indeed, you could potentially end up losing more than your initial investment amount.
Also, there is an increased risk when trading CFDs due to liquidity. If there aren’t enough trades being made for the underlying asset during your contract period, your existing contracts could become illiquid.
In this case, your CFD broker may ask for additional margin payments, or even close your contract altogether at a lower price than expected.
CFDs are considered to be so risky that the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have made trading them illegal in the US.
While they are legal in the UK, this regulation goes to show just how much risk CFDs may present.
What are stocks?
Stocks are one of the most common ways that people invest in companies around the world.
When you start stock trading, you are essentially purchasing a stake in a company. Technically, owning a stock means you “own” part of that company.
Companies typically issue stocks in order to raise capital to operate their business and fund any new planned projects.
Even though stocks and shares can be sold relatively quickly, they are usually seen as more of a long-term investment. This is because, to generate returns from selling your shares, you typically need to wait longer for them to rise in value.
How do stocks work?
When you purchase shares from stock exchanges, you will ideally need to monitor any price movements. This is because the most common way to make money from stock trading is by buying when prices are low, and then selling when your stock’s value has increased.
You could also invest in stocks and shares for dividends. These are regular payments made to an investor that depends on how many shares they hold in the first place.
Dividend investing is typically seen as a long-term investment strategy, though you should remember that not all companies offer dividend payments. So, if you want to invest for income, double-check that the company you wish to invest in offers dividend payments.
How do you invest in stocks?
Stock trading is potentially one of the easiest ways to start investing.
To start with, you need to set up a trading account with a broker. This is simple enough – just set up an account, supply any relevant details to prove your identity, and then you can start trading after you’ve deposited money.
Before investing in a company, you should ideally do adequate research. There are many different sources of information available online for researching certain stocks and shares.
Or, if you’re struggling to decide which company to invest in, there are plenty of share tips on offer, including my own weekly share tip update.
When you’ve decided which company you want to invest in, search the name or ticker symbol on your share dealing account, input the number of shares you wish to purchase, and then you can start stock trading.
When can you invest in stocks?
You can typically only conduct stock trading during the operating hours of the financial markets that the company is listed on. Thanks to differing time zones, these hours vary from country to country.
For example, the London Stock Exchange’s opening hours are from 8 am to 4.30 pm GMT. Meanwhile, the New York Stock Exchange opens from 9.30 am to 4 pm EST (2.30 pm to 9 pm GMT).
The pros and cons of CFDs
While CFD trading may sound like a good investment, there are some key things to keep in mind before you purchase.
Continue reading my guide to discover the advantages and disadvantages of CFDs.
Can get higher leverage on trades
Leverage on CFD trades means you need less initial capital for trades since you only need to meet the margin.
Having leverage allows you to invest larger sums of money with a smaller upfront investment cost.
Can usually be traded at any time of the day
Many CFD brokers offer a range of securities in major financial markets around the world which have differing stock exchange hours. This allows you to trade CFDs at any time of the day, seven days a week.
They offer a wide variety of investment options
When it comes to your options for the underlying assets to open a CFD for, you have a huge variety to choose from.
For example, you could open a CFD for stocks and shares, bonds, indices, commodities, or even for trading forex.
There may be high spreads built into the price
The spread, which is the difference between the bid price and the offer price, is often paid by the investor when it comes to trading CFDs.
In fact, the spreads may be built into the trade altogether, which could decrease your profits, or increase your losses, by a small amount.
They are typically far riskier
More than half of retail investor accounts lose money when trading CFDs since they are such complex instruments. While leverage can help you make trades that you otherwise wouldn’t be able to afford, this can also magnify your losses by a significant amount.
Also, CFDs tend to be short-term, fast-moving securities, meaning that if you don’t closely monitor any price movements, you may end up losing money rapidly.
The pros and cons of stocks
Stocks and shares also come with their own set of advantages and drawbacks, so keep reading my guide to find out what these are.
They are easy to buy
When it comes to investing in stocks and shares, they are relatively easy and straightforward to buy. Simply do some reading about a company before buying shares, execute your purchase, and then keep on top of price movements.
Buying the shares themselves is relatively easy too. Just search the name of the company on your trading account, input the number of shares you wish to purchase, and then make the trade.
They are typically more liquid
It’s typically quick and easy to sell your shares and get your money back as they are fairly liquid investments.
As long as you’re trading during the market’s operating hours, you should be able to sell most mainstream shares almost immediately.
They are well suited for long-term investing
It’s less likely for mainstream companies to significantly increase their share value in just a week. This slower-paced trading is perfect for those looking to invest for the long term.
Returns aren’t guaranteed
Like all forms of investing, there is always a risk that you could lose value on your investment.
Even if you’ve planned everything out extensively, markets could crash, seeing you lose value on your investment.
It can take a long time to see returns
While long-term investing may be a benefit of stocks and shares for some, for others this may not be suitable.
You may need to wait a long time before your shares increase in value.
The stock market can often be volatile
The stock market can be volatile, causing the values of stocks and shares to swing.
Indeed, a market crash caused by unforeseen conditions, such as the Covid-19 pandemic, could come out of nowhere and negatively impact the value of your investments.
Which is better to invest in: CFDs vs stocks?
There is no definitive answer as to which of the two is best as, generally, this all comes down to your appetite for risk and your reasons for investing in the first place.
If you prefer lower-risk investments over a longer period of time, then you may want to try your hand at trading stocks.
Meanwhile, if you are fine with extra market risk, and would prefer to trade over a shorter period of time, CFDs could be for you.
Are CFDs a good idea?
If you’re still a beginner, you may want to try stock trading rather than CFDs.
This is partly due to the fact that buying and selling CFDs is typically much riskier than stock trading. If you have a lot of leverage on your trade, you could end up losing more money than you initially invested. This is why CFDs typically require an advanced trading strategy.
Also consider: CFD Trading Platform for Beginners
CFD vs Stocks FAQs
Why are CFDs riskier than stocks?
CFDs are typically riskier than stocks mostly due to leverage. You are only required to meet the margin, which is typically a smaller percentage of the full investment amount.
So, if your trade doesn’t go your way, your losses could be magnified, and you may end up losing more money than you initially paid in.
Are CFDs good for beginners?
No, CFDs may not be good for beginners. You will typically find that to trade CFDs, you will need an in-depth knowledge of markets and trading in general. If you wish to give it a try regardless, my beginners guide to CFD trading would be a good starting point.
Also, if you’re unsure of what you’re doing, you could end up losing more money than your initial investment due to leverage.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
CFDs are complex instruments and more than half of retail investor accounts lose money when trading CFDs. Please make sure that you know these risks before you start trading and that you’re aware there’s a high chance of losing money rapidly on your investment.