15 October 2015
Sales Trader, Client Trading Services, Saxo Capital Markets
Stocks aren’t the only way to play the stock market; here are the pros and cons of trading CFDs versus stocks.
What is a CFD?
CFD stands for Contract For Difference. One CFD is usually equal to one share.
Why would I trade CFDs instead of shares?
The main reason a trader will buy or sell a CFD as opposed to the underlying stock is that a CFD, through leverage, enables retail investors to gain larger positions in the stock market without having to commit large amounts of capital.
What are the main characteristics of trading in CFDs?
Traders can take both long and short positions
CFDs are traded on leverage, which allows retail investors to gain bigger positions in the market
Currently, CFDs are exempt from UK stamp duty of 0.5% (though profits are still subject to capital gains tax)
From a single CFD account investors have access to thousands of different markets including forex and commodities
Settlement is instant and costs are transparent
CFDs appeal to a broad range of traders including sophisticated retail traders, day traders and hedge funds.
How does leverage work?
Rather than paying a broker the full price for a share, a trader will pay the provider only a small proportion (usually somewhere between 5% and 20%) of the actual contract value - this is called the margin. The trader enters into a contractual agreement with the CFD broker to exchange the cash difference in price between the opening and closing prices of the contract.
What are the dangers of trading in CFDs?
The main risk is not managing your position properly. Since trading on margin allows you to take bigger positions, your exposure to market movements will be greater, which is good if the market is moving in the right direction as your profits will be bigger, but it is bad if the market is going in the wrong direction as your losses will be magnified.
Do CFDs carry the same benefits as shares such as voting rights and dividends?
No. A CFD holder will never have access to non-economic corporate actions such as voting rights. However, a CFD holder will still be eligible to for economic benefits such as dividends and rights issues.
Why should I trade CFDs instead of stocks?
Providing you are not concerned about having access to non-economic corporate actions, you may decide to trade in CFDs based on their terms of cost, execution, flexibility and variety. You must, however, manage your costs properly, because your potential exposure to market volatility is greater.