Whether you prefer to buy stocks or trade CFDs, both approaches have specific benefits and shortcomings.
Depending on the time frame for a trader, there are specific reasons why he might prefer one type of asset over the other.
To determine whether CFDs or stocks are better suited to certain types of traders, here are 20 reasons that favour each side:
In an article entitled “Stock Market Indices Versus Individual Shares” written by James Montier, published in 2015 on ResearchGate, Stock market indices generate greater long-term returns than CFDs.
It explains how investing in an index can be more lucrative over time than shares due to compounding growth and dividend yields.
Although stocks have been shown to perform better in the long run, there are drawbacks.
Higher transaction costs when trading stocks
The transaction fees for purchasing a stock is greater than the cost of buying a CFD, where fees are typically between 0% and 5% even on small accounts.
The value of your investment can take a more significant hit if slippage while entering or exiting a trade occurs due to unexpected market volatility.
Tax implications for investors in financial instruments
When trading CFDs, interest income from borrowing funds is treated as part of the overall capital gain and taxed at the same rate.
In contrast, mortgages attract tax relief under UK law. One can offset profits by losses from other investments within his portfolio against this income stream.
Overall, this is more generous than the tax relief on interest as far as shares are concerned.
Better quality of earnings reports for stocks
The quality of earnings reports is usually better when trading stocks than CFDs.
Companies that fail to meet forecasts usually see their stock price plummet, potentially unlimited losses.
With CFDs, if a position moves against you and you stop your trade before it gets to this point, the loss is limited to the amount invested.
CFD trading can be carried out across multiple devices.
There is no need for an investor to sit at his computer screen waiting for an update on company results or news announcements under CFD trading since positions can be opened and closed at any time from anywhere, as long as the internet connection is available.
The ease of trading CFDs extends to multiple devices, including PCs, tablets and smartphones.
Stocks have higher liquidity than CFDs
Liquidity refers to entering and exiting security quickly without impacting its price.
While stock prices can vary from one minute to the next, this does not translate into wide spreads between the bid and ask quotes since traders are willing to accept a fill at any point within that range.
As a rule of thumb, stocks with lower market capitalization tend to have greater liquidity than those on major exchanges such as New York Stock Exchange (NYSE), Euronext or London.
Benefits associated with country-specific indices
Since CFDs are traded on global exchanges, you can trade the most significant indices. It is not the case for stocks since many blue-chip companies are listed only in specific countries.
UK investors cannot open positions on NYSE listed companies, whereas US customers have no access to AIM UK stocks even though both are prominent marketplaces.
More financing options offered under CFD trading
There is greater flexibility in initial and margin finance under CFD trading compared with stock trading.
While traders have to meet strict criteria before being approved for a loan with an investment firm, CFD providers have more lenient guidelines thanks to their short position lifecycle.
It’s easier to make sense of the price action during significant news events.
A new investor to CFD trading might need an experienced trader’s help during the release of important information since it can take a few seconds for price action changes to register.
Since short term movements are magnified under CFD trading, even minor adjustments to quotes caused by news announcements could result in significant percentage gains or losses.
You can trade more stocks under CFDs than you’d be able to find stocks with expiring options.
Another benefit of trading CFDs over other financial instruments is having access to contracts with monthly expiry dates.
Due to market demand and available inventory, less liquid, single stock futures can be difficult to obtain.
So even if your broker offers these products, you might only have access to specific names on certain dates depending on market activity and availability.