In this article, we are going to track different types of trading stocks CFD vs Invest, whether you are using different shares or contracts to differentiate (CFDs)
Hello friends, I'm David and in this latest article with Yahoo Finance Buddy.
I thought we'd look at a compare and contrast between two different ways of getting exposure to the stock market. Trading individual shares or using a derivative product called a contract for difference. Often known as a CFD.
Now CFDs have really grown in popularity over the last 20 years amongst retail private investors they use them for trading indices currencies commodities. But where they started was for individual shares.
So let's start looking at the different benefits and drawbacks of using these two approaches. So, first of all, let's look at the main headline differences of trading shares, stocks and equities whatever you want to call them.
With these two different approaches: So on the left-hand side we have equities to buying traditional shares or stocks whatever name you want to give it and on the right-hand side, we have CFDs contract for difference. The derivative-based off what the share price is doing
Equity (Invest) |
CFD (Contract for Difference) |
|
No Leverage |
Leverage |
I think the main headline difference is this idea of leverage. Now we've talked about this before in this article. But, just to recap when you're using leverage in effect you're getting more bang for your buck.
So let's say you're going to buy £10,000 worth of shares. let's look at both approaches so
if we're buying £10,000 of actual physical shares or physical equity. Typically there's no leverage.
£10,000 of Shares |
Just £1000 initial margin required |
If we're buying shares so if you want to have £10,000 worth of PT, for example, you need £10,000 in your account plus the commission plus the stamp duty will come to all that in a minute.
But we see if these were trading on margin. So let's say the share, we were going to trade was on an initial margin requirement of 10%. What that means is we only have to put up 10% of the value of the position.
We've still got a £10,000 exposure to this particular share. But our initial margin is only a thousand pounds. So we are getting more bang for our buck. Of course, the risk is.
If the share is falling if we've bought it and it's falling we bought a CFD.
We need to make sure there's enough money in the account to cover those running losses.
If we need to run the position, but this leverage is the big headline difference between the two of them.
Now the next big difference between CFDs and physical shares. Is it's actually the direction you can trade them. In traditionally with individual equities individual shares as a private investor. You're limited to trying to profit.
If the share goes up, so you're hoping to buy low and sell at some point higher up.
Now if markets are falling, one way of making money is to short sell to sell high and buy back lower.
|
No Strength |
Trade Both Ways |
But it's very difficult. If not impossible for your average private investor to do that through a traditional share buying account but with CFDs contracts for the difference you can trade them in both directions.
So it's just as easy to put a trade on expecting the price of, let's say Netflix to fall and profit from it as it is. If you thought the price of Microsoft was going to go up.
You're going to buy it first so you can trade it in both directions using CFDs. You can't do that with individual equities.
Let's look at some of the costs for UK equities. At least if you buy shares in a UK company.
|
Stamp Duty |
No Stamp Duty |
Traditionally there's this stamp duty to pay. It's a tax basically made by the government of around half a per cent on a share purchase on the total value of the shares, you've bought.
So there's a tax there with CFDs because they're not actually the physical shares. It's a derivative, there's no stamp duty to pay. So there is a saving there.
Another cost actually that you have with CFDs contracts. The difference that you don't have with equities financing it's all because of this leverage.
|
No Financing |
Financing |
Here you know if you're buying ten thousand pounds worth of shares in British Aerospace. But you're only putting up a thousand pounds to control that position. In effect you're borrowing money off your broker, to do the trade. And as we all know when you borrow money there's a small financing cost there's a small overnight financing cost to reflect your total exposure.
I think if you were looking to hold a share for 12 months, two years, five years. Probably buying the physical shares is the way most people would do it. But for other, short to medium-term trades. There are definite benefits in using contracts for difference (CFDs).
Of course, if you're trading shares through with us. You get a commission feed. Free trading up to a certain amount of trades per month. Go to the website to find out more and there's only a small commission if you're trading using CFDs.
But we'll start wrapping things up there, as usual, any questions or comments or you're not sure of anything. Leave us a message on the sites Contact Us Page.
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Good Day friends.