What is the main difference between CFD and share trading?

This is one of the most common questions we see new traders ask, and really, there are two answers, depending on which kind of share trading you’re talking about.

When you trade shares, you profit or lose money based on whether the share price goes up or down. You can go short or long on the position, depending on if you believe the price will move up or down.

Both of these things are true of shares CFDs, too.

However, the main difference with CFDs – and this is where people get confused – is that with a CFD trade, you don’t actually own the shares.

You’re simply ‘speculating’ on whether the price will go up or down.

• If you trade 100 Apple shares, while the trade is open, you are an Apple shareholder. You have a financial agreement with Apple.
• If you trade the value of 100 Apple shares through a CFD, you have no financial link to Apple. Instead, your contract is with a CFD broker.

The other key difference is that CFD traders usually make use of leverage. (Which we’ll cover in more depth in a moment.)

So, should I trade directly, or trade using CFDs?

This is down to your own financial goals, and we’d never give direct advice.

What we can do is go through the pros and cons of CFDs versus traditional share trading.

Pros of CFDs:

• Leverage can allow you to enter larger trades without having to supply all the capital upfront, giving you the chance to make larger returns.
• It’s simple to go long or short. Traditional short-selling can be quite a complex process, and isn’t recommended for less experienced traders. With CFDs, long and short trades are executed in the same way.
• CFDs are available around the clock. Usually, you can place CFDs on a 24/5 basis. Traditional share trading is only open when the stock market is open. (Though it’s worth noting that if you place a CFD trade outside of market hours, you may have to wait until the market opens for it to be fully executed.)

Cons of CFDs:

•  Leverage opens you up to more risk. When you use leverage within CFDs, you can lose more than your initial capital. This isn’t the case with traditional share trading, where your loss is always capped at the amount of capital you invest.
•  CFDs usually mean spread and rollover costs. The ‘Spread’ is the difference between the price your broker will buy at, and the price they will sell at. It’s a standard cost associated with CFDs, and doesn’t apply to traditional share trading. (Though you may have to pay commissions on traditional share trades.)
• No voting rights on the company. If you’re a shareholder in a company, you get some rights associated with that, such as votes on the managing board. These rights don’t apply to CFD holders.

Are CFDs riskier than share trading?

If you use leverage, then yes. Leverage magnifies your chance at larger profits, but it also increases your risk, and opens up the possibility that you could lose more than you trade with.

This is why leverage can be popular with traders. However, the same principle applies to any losses, too.

So, if you’d lost 20% on the trade, your losses would have been $2,000. In other words, you’d have lost double what you put in.

The more leverage you use, the more potential for a larger return, but also the more potential for losing substantially more money than you traded with.

Understandably, many traders choose to avoid using leverage entirely, because they simply aren’t comfortable with the idea of losing more than they put in.

Whether you choose to use leverage is down to your own appetite for risk and what your financial resources are.

As always, you should never trade with money you can’t afford to lose.

Summing up

The 2 key differences between CFDs and more traditional share trading are:

• CFDs mean you don’t actually own the shares
• CFDs mean you can use leverage

Though there are other key differences, such as trading hours, associate costs and shareholder rights.

Whether you use CFDs or stick with traditional shares is largely down to your own appetite for risk and how much capital you have to trade with.

Never trade with more money than you can afford to lose.