Contract For Differences (CFD) – Chapter 7: Shares Trading Versus CFD’s Trading

This is chapter number 7 out of 12. Read the rest:

Read Contract For Differences (CFD) – Chapter 1: An Introduction to CFD’s
Read Contract For Differences (CFD) – Chapter 2: The benefits of CFD’s
Read Contract For Differences (CFD) – Chapter 3: The risks of investing in CFD’s
Read Contract For Differences (CFD) – Chapter 4: The Main Features of the CFD’s
Read Contract For Differences (CFD) – Chapter 5: Trading In Bullish & Bearish Markets
Read Contract For Differences (CFD) – Chapter 6: How CFD’s work

There are a few major differences between trading in shares and CFDs. It is crucial that you are fully aware of these differences so that you can fully understand their implications. Below are listed the main differences between Shares and CFDs.

1. Characteristics of the Trade:

Shares:

When a trader trades shares, he is buying or selling shares of the companies in question or in some cases, a mutual fund. His profitability is not limited if the market is on a bull run and the option of short selling shares is normally not available.

CFDs:

CFDs are financial instruments which are linked to the shares of individual companies, indices, commodities and currencies. Traders have the opportunity to profit from both a bullish or bearish market by either going “long” or “short” in their trading.

2. Ownership:

Shares:

By buying shares in a company, you are actually purchasing a stake in the said company. This mean that you have the right to vote who the board members can be, have a right to the assets of the company and will receive a dividend if the company declares a dividend.

CFDs:

CFD on the other hand is a private arrangement between two parties, the brokerage firm or CFD provider and the trader. You are just making a contract between the other party for financial purposes and you are not buying any shares within the company itself.

3. Stamp Duties:

Shares:

All purchases ofUKlisted shares are subjected to 0.5% in stamp duties payable to the UK Government.

CFDs:

As CFDs are not involving the purchasing of any shares, there is no stamp duty payable for CFD trading.

4. Margin Trading:

Shares:

To trade in the equity market, you will need to come up with 100% of the capital that is required for any investment at the first instance.

CFDs:

Depending on the margin requirement of the individual CFD providers, trades in CFDs only require a small initial capital outlay or margin. This margin can be as low as 5% of the volume traded.

5. Potential Profitability and Losses:

Shares:

Profitability or losses are limited to the percentage of market movement. Thus, a 10% swing uptrend will typically yield a price premium of 10% and vice versa.

CFDs:

Due to the leveraging factor associated with margin trading, the profitability level or potential losses are magnified several fold over. Thus a typical 10% swing uptrend will typically yield a profit of around 100%. However, you have to note that your potential for losses is also magnified several times over as well.

6. Maximum Losses:

Shares:

Even if the company in which you invested your share in went bankrupt, your maximum loss that you will incur is limited to what you invested initially. For example, you invested $20,000, than you will just suffer a maximum loss of $20,000 when the value of the stock drops down to zero. There is no “bottomless pit” that you will have the potential of facing.

CFDs:

Trading in CFDs is riskier as you utilizing leverage to maximize your returns. Therefore, you can lose much more than your initial investment. The maximum potential loss depends on the market position that you are holding. For those of you who went “long”, your losses are limited to the total value of the CFD that you exposed yourself to. For example, you purchased $20,000 worth of shares with a margin deposit of $2,000. Thus, if everything goes sour, your maximum potential loss is $20,000. However, if you took up a “short” market position, if the market moves against you, technically speaking, your potential loss is unlimited as there is actually no limit as to how high a market can go in theory. Therefore, it is crucial that you monitor closely your open short market position.

7. Order Types:

Shares:

When you trade in shares, you have several types of market order at your disposal to help you facilitate your trading. You also have limit orders and stop loss to help mitigate your loss in the event the market moves against you.

CFDs:

CFDs trading also have the same order types as those in share trading. The only difference between share trading and CFD trading is that CFD trading has an additional order type called ‘Guaranteed Stop’ order to limit your maximum loss.

8. Dividend:

Shares:

Dividend payout is credited to your trading account and you have the option to cash out or reinvest it.

CFDs:

If you are holding a long position in the market, than dividend adjustments will be made and credited to your trading account. However, if you are holding a short market position, the amount will be deducted from your trading account.

9. The Duration of the Investment:

Shares:

This market is suited for both short and long term investment objectives.

CFDs:

CFDs are normally used by investors who have short term investment objectives. As such, they enter and exit the market more often.

Read Contract For Differences (CFD) – Chapter 8: Available Markets for Trading CFD’s
Read Contract For Differences (CFD) – Chapter 9: The differences between Spread betting and CFD Trading
Read Contract For Differences (CFD) – Chapter 10: CFD Trading With Stop Losses
Read Contract For Differences (CFD) – Chapter 11: Other Types of Orders
Read Contract For Differences (CFD) – Chapter 12: Conclusion