Share trading vs CFD trading: What’s the difference?
When trading in financial markets, traders need to choose a method aligned with their goals and risk tolerance. Share trading and CFD trading are both popular approaches, but they operate in fundamentally different ways.
Understanding the differences of share trading vs CFD trading is essential for both novice and intermediate traders. Each approach has benefits and risks, and knowing these can help traders decide which method aligns best with their objectives. Beyond recognising the merits and drawbacks of share trading vs CFD trading, traders must understand the mechanics of each approach, including the key differences between them.
What is share trading?
Share trading—or stock trading—involves buying and selling shares, each representing a stake in a company. When a trader buys shares, they acquire a small part of the company, with the potential to benefit if the share price increases. In some instances, shareholders may also receive dividends, which are portions of a company’s profits distributed to investors.
Share trading is commonly viewed as a long-term strategy. The aim of long-term investors is to benefit from capital appreciation over time as the company grows and its stock value rises. Depending on the company's performance and the number of shares held, quarterly dividend payments can contribute favourably to the return on investment.
As with any trading strategy, there are risks involved. Chief amongst these are price movements influenced by market conditions and the company's performance. With some companies, a long-term investment can see these fluctuations smoothed out and a return on the initial investment. Though not as frequent as price movements, market crashes can result in significant declines in share value. Once the market rebounds, some shares can take longer than others to recover.
When considering share trading vs CFD trading, share trading may appeal more to traders with a long-term outlook that focuses on gradual capital appreciation.
What is CFD trading?
CFD (Contract for Difference) trading is a type of derivative trading where traders speculate on the price movements of assets without owning the underlying asset itself. Unlike share trading, CFD traders do not hold shares in a company. Instead, they enter a contract with a broker to benefit from the price difference between the opening and closing positions.
CFD trading is particularly attractive because of leverage, which allows traders to control larger positions with a smaller capital outlay. However, while leverage can magnify gains, it also increases the risk of larger losses since gains or losses are calculated on the actual position, not the initial capital outlay. Financial derivatives like CFDs allow traders to speculate on both rising and falling markets, providing greater flexibility than share trading.
CFD trading involves higher market volatility, with traders speculating on short-term movements. Additionally, positions moving against a trader can result in margin calls requiring additional funds to be deposited to maintain the position.
Key Differences Between Share Trading and CFD Trading
Both share trading and CFD trading focus on price movements. But share trading focuses on positive price movements, whereas CFD trading allows speculation on both increases and decreases. There are other key differences to know:
Criteria | Share Trading | CFD Trading |
|---|---|---|
| Ownership | Traders own the shares they buy, giving them a stake in the company as long as they hold onto the shares. | There is no ownership of any assets. Traders speculate on price changes without ever owning any assets. |
| Leverage | There is no leverage in share trading. Traders can only buy shares matching their available capital. | CFD leverage allows traders to control larger positions with less capital. Traders only need to deposit a fraction of the position's value, as long as the position doesn't move against them. |
| Duration | Generally a long-term strategy with gains typically realised after holding shares for a period. | Short-term strategy, with traders taking advantage of rapid price movements. Most positions are only held for a short period. |
| Costs & Fees | In addition to the value of the shares being bought or sold, brokerage charges or commission is usually payable. Some brokers might charge a flat fee while others charge a percentage of the trade value. | The primary cost when trading CFDs is the spread—the difference between the buy and the sell price. For example, on a currency pair trade, the buy price is 1.2052 and the sell price is 1.2050. The spread here would be 0.0002, which, if trading a mini lot, would amount to $2. Spreads can seem low on individual transactions, but when trading frequently, they add up. There is typically no commission on forex and commodity CFDs. Swaps—or rollover fees—are also charged on positions held overnight. |
| Tax | Dividends are taxed in many countries, though tax policies can vary significantly. Other than that, capital gains tax applies when shares are sold at a profit. Some countries have different tax rates for long-term and short-term capital gains. | Taxes on CFD trades can be more complicated depending on a trader's location. While tax applies only to profits, it may be considered capital gains or income tax, further influenced by whether trading is an individual’s primary income source. |
| Risk Management | Ownership of the underlying asset translates into lower risk, since losses are limited to the amount invested. The main risks are market volatility and price fluctuations. Holding shares long-term can reduce the impact of market swings which are frequently short-term in nature. Dividends, if paid out, can also help stabilise returns. Risk management in trading stocks should include portfolio diversification, across sectors and geographies, along with investing in financially stable companies. | Leverage means significantly higher risk, since both potential gains and losses can be magnified. This can lead to losses exceeding the initial investment. Stop-loss orders are a key risk management tool, limiting losses by automatically closing positions if the price falls to a specific level. Beginners can manage risk by practising with demo accounts on online trading platforms. By practising in real-time market conditions, traders can experiment with strategies and understand the impact of CFD leverage on gains and losses. |
Pros and cons of share trading
Share trading is ideally suited to traders looking for long-term growth through the stock market. However, there are advantages and disadvantages to this trading strategy.
Pros of Share Trading
- Long-term growth potential: Share trading is often seen as a pathway to long-term wealth creation. Traders benefit from the increase in share prices when buying shares in companies that perform well over time. The stock market tends to grow over the long term, so stock trading appeals to those who have the patience and financial security to ride out market fluctuations.
- Ownership of shares provides dividends: One of the most attractive features of share trading is the potential to receive dividends. Not all listed companies pay dividends, but shareholders of profitable companies that do, have an additional income stream. Dividends can be reinvested to compound returns.
- Usually less volatile than CFD trading: Share trading is generally less volatile compared to CFD trading because it doesn’t involve leverage. While stock prices can fluctuate, the risks are generally lower than those encountered in highly leveraged CFD positions. This can make share trading a more stable option for traders who prefer a low level of risk management in trading.
- Easier for new traders to understand: The mechanics of share trading are relatively simple: buy shares, hold them, and sell them at a higher price to make a profit. For new traders, this straightforward process is easier to grasp compared to the complexities of derivative products like CFDs, which involve leverage and other advanced trading concepts.
Cons of share trading
- Requires significant capital to start: One of the major downsides of share trading is the capital required to get started. Purchasing shares outright can be expensive, especially in blue-chip companies where stock prices are high. Effectively diversifying a portfolio can require large sums, a potential barrier for new traders with smaller budgets.
- Lower liquidity compared to CFDs: Stocks are generally liquid, but selling shares to access cash can take longer than closing a CFD position. Some shares, especially in less-traded companies, may also be harder to sell quickly without affecting the price. This lower liquidity can be a disadvantage for traders needing fast access to funds or wanting to react quickly to market changes.
- Returns can be slow: As already highlighted, share trading is traditionally a long-term trading strategy. This means that the returns are often slower to realise compared to short-term speculative trading. Significant capital growth can take years, which can be frustrating for traders looking for quick gains.
Pros and cons of CFD trading
CFD trading allows traders to take advantage of price movements in either direction, using leverage to control larger positions with less capital. However, there are significant risks countering the benefits of CFD trading. Traders need to balance these as part of an effective trading strategy.
Pros of CFD Trading
- Leverage allows control of larger positions with less capital: The use of leverage is an appealing aspect of CFD trading. Leverage allows traders to open larger positions than would be possible with the capital they have available. With leverage, a trader might control $10,000 in stock with only $1,000. This makes CFD trading accessible to those with smaller budgets. Leverage can amplify potential gains, but it also increases risk.
- Ability to benefit from both rising and falling markets: CFD trading allows traders to speculate on both upward and downward price movements. If the price of an asset is expected to fall, traders can “short” the market by selling CFDs, with the potential to take advantage of the decline. This can be advantageous in highly volatile or bearish markets where traditional share traders could be forced to wait for a rebound on share prices.
- Lower initial capital required: The capital required to trade financial derivatives like CFDs is much lower than in traditional share trading, thanks to leverage. Only a small percentage of the asset's value is needed to open a position. This can make CFD trading accessible to a broader range of people, as long as they have a deep understanding of the risks involved.
- More flexible trading hours: Unlike traditional stock markets, CFD markets typically operate 24 hours a day, five days a week. This allows traders to access global markets, react to market news in real-time, and to take advantage of price movements outside of their own country's trading day.
Cons of CFD trading
- Higher risk due to leverage and margin calls: Leverage magnifies potential gains, but it also increases the risk of significant losses. Small market movements can have a substantial impact on the value of a leveraged position, and if the market moves against a trader, losses can quickly exceed the initial capital invested. If a position moves into a loss, traders may be required to deposit additional funds to maintain their position (known as a margin call). This can increase financial pressure and lead to impulsive, reactionary decisions.
- Overnight fees can add to costs: holding CFD positions overnight results in overnight fees. These fees accumulate daily and can eat into gains, particularly for longer-term trades. Because of this, CFDs are more suitable for short-term trading, where positions are closed within a day.
- Increased volatility compared to share trading: CFD markets tend to be more volatile, and price swings can be much sharper. For traders unfamiliar with this level of volatility, the higher risk can be overwhelming, leading to significant financial losses.
Contrasting share trading vs CFD trading means understanding that they offer different approaches to financial instruments, each with benefits and risks. Share trading can be more suitable for those looking for long-term investments with potential dividends and ownership stakes, whereas CFD trading suits those after short-term gains and flexibility through leverage. The choice between trading methods depends on financial goals and risk tolerance. However, establishing these comes from knowing what the differences in ownership, leverage, and risk are. Both newer and experienced traders can benefit from further research and through practising in a controlled environment using online trading platforms.
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