CFD Trading vs Stocks: A Beginner’s Guide

What is CFD trading, and how does it compare to traditional investing? This guide breaks down the essentials of CFD trading and compares it to stock investing. By the end, you’ll have a clear understanding of how CFD trading works and whether it’s the right approach for your financial goals. We’ll be covering:

• What Is CFD Trading?
• What Is Stock Trading?
• Key Differences Between CFD Trading and Stock Trading
• Example of How CFD Trading Works
• Example of How Stock Trading Works
• Conclusion: Trade CFDs Online

Keep reading to learn more about CFD trading and how to do it safely online.

What Is CFD Trading?

CFD trading is the act of buying and selling Contracts for Difference (CFDs), financial instruments that allow you to trade the price movements of underlying assets. A CFD derives its value from an underlying asset, but it is not the underlying asset. That’s why we class CFDs as derivatives. This means you don’t own the underlying asset when you’re trading CFDs. Instead, you’re speculating on the price.

The fact you’re speculating on price movements means you can go long (buy) or short (sell). Going long means you expect the underlying asset’s value to increase over time.

Therefore, you “buy” the CFD at the current price with the aim of selling when it increases in value.

You can go short if you believe the underlying asset’s value will decrease. Short-selling involves borrowing the asset for an agreed price. You then sell that asset in the market and try to buy it back for a lower price in the future. You then return the asset and keep the difference between the original price you sold it for and the price you paid to buy it back.

As well as having the flexibility to take long or short positions, online CFD trading covers a variety of asset classes. Through CFDs, you can speculate on the price movements of various financial instruments because you don’t have to own the underlying asset. The asset classes you can trade with a CFD account at TMGM are:

• Forex
• Stocks and shares
• Precious metals, such as gold
• Energies and resources, such as oil
• Indices (an index that tracks the performance of multiple assets)
• Cryptocurrencies

What Is Stock Trading?

Stock trading is the act of buying and selling shares in companies. Already, you can see how trading stocks and shares is different from CFD trading. When you buy stock, you own it. The underlying asset is yours, and it entitles you to a stake in the company.

Having a stake in the company means you share its ups and downs. Put another way, the value of your asset increases when the company’s share price increases. Conversely, the value of your asset decreases when the company’s share price decreases.

Having a stake in the company can also give you voting rights and access to dividends. Voting rights can concern matters such as board member changes and financial issues. Dividends are payments distributed to shareholders. The money is taken from the company’s profits and paid on a per-share basis

These factors lead to stock trading generally being seen as a long-term strategy. That’s why people often refer to stocks and shares trading as “investing”. Your goal is to buy shares at a price you believe represents a discount to the company’s true value. You hold these shares with the hope that the company grows and the share price increases. In other words, you’re investing now with the hope of making a profit in the future.

What is CFD stock trading, and is it the same as investing?

CFD stock trading allows you to profit when a company’s share price increases, but it isn’t the same as investing. If you’re stock CFD trading, you’re going long on the price without owning shares in a company. This allows you to make a profit if the company’s share price increases, but it doesn’t give you voting rights or access to dividends.

Key Differences Between CFD Trading and Stock Trading

CFD vs stock trading is the ultimate debate. Both offer a flexible trading style but in different ways. CFD trading can be made with a whole range of styles such as scalping or day trading while stocks are best suited for those investors who wish to own the underlying asset. We’ve outlined the key differences below to help you better understand the opportunities in each.

CFDs Are Derivatives

CFDs are derivatives, which means their value is derived from an underlying asset. This means you’re trading the derivative’s price rather than owning the underlying asset.

CFD Allow Leverage

With leverage, you can take a position without putting up the full amount of money. For example, if you have access to 1:10 leverage and a standard position is $1,000, you’d need to commit $100 to the trade. You can access leverage via a CFD trading account.

Leverage allows you to take positions you otherwise wouldn’t be able to. The downside is that it magnifies your losses on a negative trade. You can’t invest with leverage via a stocks and shares trading account.

CFD Profits Come from Predicting Price Movements

CFD stock trading focuses on predicting price movements in either direction (positive or negative). Investing is rarely a short-term strategy, as it focuses on an asset’s potential for growth so that its value increases.

CFDs Can Profit from Going Long and Short

The fact that you don’t own the underlying asset with CFD trading means you can speculate on price movements - increasing or decreasing. When you invest in stocks, you only make a profit when the asset’s value increases.

CFDs Are Shorter-Term Trading Assets

A lot of the CFD vs. stock trading debate focuses on short vs. long-term strategies. In general, CFD trading is used as a short-term strategy simply because you can go long or short. Therefore, you can try to trade in line with the market’s ebbs and flows.

In contrast, investing is a long-term strategy because you only make money if the asset’s value increases. This can take time, which is why it’s advisable to invest in something you’re prepared to own a stake in for at least a few months but, ideally, a few years.

Having said this, CFD stock trading can be a long-term strategy. It’s possible to hold a long position for a long time without a lot of capital.

You can also hold a short position for an extended period of time, but the fact you may be trading with leverage means you need a lot of funds for it. There’s more volatility in short positions, so it’s usually only those with a lot of experience who do it; and even then, sparingly.

Example of How CFD Trading Works

The whole process of trading CFDs is run electronically with CFD trading platforms which you can run through an internet browser, download to your computer, or even use on a mobile device. The platforms we provide include two of the most popular on the market: the intuitive and widely-used MetaTrader 4 (MT4) and its successor, with advanced features, MetaTrader 5 (MT5).

To calculate profit and loss when taking a long position with CFDs, you’ll work with the following formula:

Profit = End value of contracts bought - Initial trade value
Where:

• The initial trade value is calculated by multiplying the contract price by the number of units the trader wants to buy
• The end value of contracts bought is calculated by multiplying the number of contracts bought by the price when the trader closes the position.
• Net profit = Profit - any charges or commissions applied

Here’s a CFD trading example to help you understand the process of going long:

1. You take a long position in Company X, buying one contract at $10 a share because you believe the price will increase.
2. The share price hits $15.
3. So, you decide to close your position and bank the difference between $15 and $10.
   
   i.e. $15 - $10 = $5 profit.

Going short is a little different, as it requires you to first “borrow” an asset to sell when you believe it is likely to sink lower and later buy it back for a profit.

You’ll calculate profit and loss with the following formula:

Profit = Value of borrowed asset upon buy back - Value of borrowed asset upon selling
Where:

• The value of the borrowed asset upon selling lated by multiplying the contract price by the number of units the trader wants to borrow and sell.
• The value of the borrowed asset upon buy back lated by multiplying the number of contracts bought by the price when the trader closes the position.
• Net profit = Profit - any charges or commissions applied, including any borrowing costs.

Here is an example :

1. Let’s say you take a short position at $10, i.e., you borrow and sell the asset for $10.
2. The price drops to $8.
3. You close your position (i.e., buy back the CFD) and bank the difference between the first and second price, making you a $2 profit.
   
   i.e. $10 - $8 = $2 profit.

If you’re trading CFDs with leverage, you need to calculate the margin required for a trade. Let’s say you’ve got access to 1:20 leverage. This means you can take a $20 position for every $1 in your account.

You’re essentially receiving a loan in this situation, so you need to maintain a certain amount of money in your CFD trading account. The minimum amount is determined by the margin, which is calculated as a percentage: if you’ve got access to 1:20 leverage, the margin calculation is 1/20 = 0.05 x 100 = 5%, i.e., you need a balance of at least 5% of the position’s value.

Example of How Stock Trading Works

Stock and shares trading is arguably a simpler concept than CFD trading because the value of your investment is 1:1. That means you pay whatever the current share price is, and the amount you make directly correlates to its current value.

For example:

• You pay $20 for one share in a company listed on the London Stock Exchange.
• Its share price goes up to $25, and your asset is now worth $25. You’d make a $5 profit if you sold at $25.
• Conversely, if the share price drops to $15, and you sell, you’d lose $5.

The best way to think about trading stocks and shares is that profit or loss correlates with the financial performance of the company.

Conclusion

Should you trade CFDs or invest? Only you can answer that question based on how the facts we’ve given you fit into your personal preferences and situation. One key consideration before you start is whether you want to make a long-term commitment or maintain the flexibility to ebb and flow with the financial markets.

If the flexibility and opportunities appeals to you, a CFD trading account at TMGM may be the right fit. There are no guarantees when it comes to trading or investing, but CFDs can be a means of establishing a diversified portfolio. To get started and enjoy low trading fees on thousands of instruments, create an account at TMGM today.