CFDs and investing are two separate ways to take a position on a market’s price movements. On the surface, that makes them seem similar – but they work in very different ways. Because unlike investing, with CFD tradingyou don’t ever own the asset you’re trading.
How investing works
When you invest in a market (such as a stock), you usually buy it and add it to your portfolio.
Then, when the time comes to close your position you sell it on and collect the difference in its price as profit – unless you have to sell it for a loss.
How CFDs work
When you trade a market via CFDs, you don’t buy it and add it to your portfolio. Instead, you buy a contract for difference (CFD). This is a type of financial product that tracks the live price of a specific financial asset, such as a stock, index or forex pair.
When you close your position, you’ll exchange the difference in the asset’s price with your provider. If it’s gone up, you’ll earn a profit. If it’s fallen, you’ll earn a loss.
Learn more about CFDs.
As you can see, the end result from both transactions is the same. Buying 50 Apple CFDs gives you the same exposure as buying 50 Apple shares. But because you never own the underlying asset with CFDs, you can access some useful benefits for active traders.
See how CFDs work first hand
The best way to get to grips with CFD trading is by diving in with a free risk-free demo account. These work just like live trading accounts, but all the money is virtual – so you can learn the ropes without risking any funds. All you need is an email address.
Get your demo account here
Benefits of CFD trading
Let’s take a look at three major benefits of CFD trading: leverage, going short and the range of markets available.
Leverage
When you buy a CFD, you don’t necessarily have to pay for the full price of your position upfront.
Let’s return to our Apple example above. If Apple is trading at $150, then buying 50 shares would cost $7,500. With investing, you’ll need to pay that full $7500 to open your trade. With CFDs, you might only need 20% of your position’s price in your account – in this instance, $1,500.
Despite only putting down 20% of your position’s total value, your profit or loss is still based on its full size. So you can earn 100% of a transaction’s gains – or losses.
Going short
So far, we’ve only looked at going long by buying markets with CFDs. But because you don’t own the underlying asset, you’re not limited to long positions with contracts for difference. You can go short by selling a market at the outset instead.
Shorting gives you a position that will profit if the underlying asset price falls instead of rising. It can be a useful method of targeting returns in bearish conditions.
It is technically possible to go short when share dealing. But for most investors, it’s a complex process that involves borrowing and reselling stocks. With CFDs, the process is the same as going long – you just choose ‘sell’ instead of ‘buy’.
What can I trade?
With share dealing, you can only access a narrow range of asset classes: typically sharesand ETFs.
With CFDs, on the other hand, you can deal in a vast range of markets: forex, commodities, stock indices, shares, ETFs and more. You can even trade on the prices of bonds, optionsand interest rates.
For example, City Index offers over 5,000 global CFD markets. Using a single platform and account, you can take your position on EUR/USD, Amazon, the FTSE 100, gold and much more.
To see our full range of markets – and trade them risk free – open a demo account.
CFDs vs investing: tax
One other key benefit of CFDs over investing is that CFDs are totally free from stamp duty – whereas investing isn’t. You will, however, still need to pay capital gains tax.*
How to start CFD trading
Follow these five steps to start trading CFDs with City Index today:
- Open a live account to trade CFDs with real funds a demo account to develop your skills with virtual capital
- Add funds using debit card, credit card, PayPal or bank transfer
- Choose a market from the 1000s available
- Buy (go long) if you think your market’s price will rise or sell (go short) if you believe it will fall
- Execute your trade, remembering to use stops and limits to control your risk
Benefits of investing
CFDs are a powerful tool, but they aren’t for everyone. Let’s take a look at some key benefits of investing over CFD trading.
Lower risk
When you trade on leverage, you’re essentially amplifying your exposure without committing extra capital. While this has the potential to increase your profits, it will also increase your losses, which makes CFD trading riskier than investing – although you can limit your risk with stop losses and take profits.
Dividends
Some companies choose to pay a share of their profits back to shareholders in the form of a dividend. With CFDs, you won’t receive this payment. Instead, we’ll update your position to reflect the dividend.
If you’re planning a yield-based strategy, investing is probably the better option.
No overnight financing
When you keep a long CFD position open overnight, you’ll pay interest on the leverage you’ve used. So for long-term positions, investing can be more cost effective.
CFDs are often popular with active traders who might only keep positions open for hours or days. Investors, on the other hand, are mostly more passive.
CFD vs investing example
The easiest way to understand the difference between CFDs and share dealing is with an example.
Let’s say ABC plc is trading with a sell/buy price of 130p/132p, and you want to open a long position.
Trading ABC CFDs
You decide to buy 1,000 ABC CFDs because you think the company’s price will rise.
The CFD for ABC has a margin rate of 20%, which means you need 20% of the position’s total value in your account to open the trade. 1,000 x 132 is £1,320, so your margin is £264.
ABC stock rises to a sell/buy price of 137p/139p. You close your position by selling at 137p (the new sell price).
ABC has moved 5 points (132 to 137) in your favour. Multiplied by your position’s size (1,000 units), your gross profit is £50.00. You’d pay commission to open the trade, which would lower your total profit.
If ABC had fallen 5 points, you’d have lost £50 (plus commission).
Investing in ABC shares
You buy 1,000 ABC shares with share dealing.
You’re investing, so you need to buy the shares outright. To buy 1,000 shares in company ABC, you’d need £1,320.
If ABC hits 137/139p, then you can sell your shares for £1,370, earning you a £50 gross profit.
Again, your total profit would be £50 minus any commissions or broker fees.
If ABC had fallen five points you’d lose £50.
CFD trading vs share dealing, which is best for me?
Now we know the benefits of both products, you should be able to choose which you want to get started with. To help you out, here’s a quick recap:
CFDs might be for you if you want:
- Access to over 13,500 markets, including forex, commodities, indices, shares and more
- To trade on leverage
- The option to go short as well as long
- To save on stamp duty*
Share dealing might be for you if you:
- Are happy sticking to global stocks and ETFs
- Are comfortable committing to the full value of the position upfront
- Want to take ownership of the asset
- Want to profit from dividends
* Spread Betting and CFD Trading are exempt from UK stamp duty. Spread betting is also exempt from UK Capital Gains Tax. However, tax laws are subject to change and depend on individual circ*mstances. Please seek independent advice if necessary.
Summary of differences between CFD trading and share trading
Feature | CFD trading | Shares dealing |
|---|---|---|
| Free from Stamp Duty* |  | |
| Commission charged | | |
| Ability to go long – buy and take advantage of rising prices | | |
| Ability to go short – sell and take advantage of falling prices | | |
| Ability to hedge – go short and mitigate against potential losses in your shares portfolio | | |
| Leveraged trading – gain a large exposure for a fraction of the value | | |
| Immediate dealing – instant trading both in and out of a market | | |
| Access to other asset classes – such as indices, FX, etc | | |
| Access to global shares – trade over 5000 different markets from around the world | | |
| Receive dividend and interest adjustments | | |
| Physical ownership – benefits include the ability to attend AGMs | | |
| Pay overnight financing charge | |
