As we previously explored the differences between trading stocks and forex, let’s now look into the difference between Stocks and Stock CFDs. Many MT4 forex brokers offer trading in stocks. In some cases these are also marketed as stock trading. However, on closer observation, the stocks that you see on your trading platform are actually quite different from the stocks that you would trade at an exchange.
Contracts for difference or CFD for short, is a derivative product. The contract for difference allows traders and speculators to make use of the instrument in order to speculate on the price movement of the underlying instrument or security.
There are many different CFDs, ranging from stocks to stock indexes, bonds and many precious metals and commodities. The pricing of these CFDs are derived from the underlying cash market instruments.
For example, if you were to trade the stock CFD for Apple, you are trading the derivative instrument of the stock (Apple) whose price is derived from the actual price of Apple stocks traded at an exchange.
Main differences between stock CFD’s and stocks
- You do not own the actual shares when you trade CFDs
- With stock CFDs you can be long or short on the instrument
- Stock CFDs pricing is often marked up and also attracts overnight swap rates
- Stock CFDs entitles you to a credit or debit of the dividends (depending on your position)
- Stock CFDs are widely used as a hedging tool
Trading stock CFDs offers quite a few benefits, especially for those who do not have access to trading the stick directly or have limited capital. Stock CFDs or CFDs in general are leverage products. This is one of the main reasons why traders often prefer to trade stock CFDs for lack of other alternatives.
For example, if the share price for a stock is trading at $100, and you buy 10 shares, you would need to put up $10,000 in capital to purchase the stock. Whereas, if you were to buy the same stock as a contract for difference you would have to put up just $200 at 1:50 leverage.
This makes is very easy for the average speculator to pick up the stock CFDs rather than the stock itself. There is not much difference in the pricing between the stock CFD and the actual stock price itself. However, you can expect a mark up on the prices. A CFD is usually marked up higher by a few ticks or cents and the spread (the difference between the bid and ask price) which is also comparatively higher than the actual stock.
When you trade stock CFDs you do not own the actual shares of the stocks that you are trading. This is one big difference between the stock CFD and the actual stock itself. However, if the stock pays dividends, you do get paid these dividends as well.
Another factor that makes stock CFDs different from stocks is the fact that you can be long or short on the CFD. This is not easily possible when you trade stocks. Short selling stocks requires a bit of nack and is also considered unethical in some aspects. You can of course sell your shares you if actually own them, but short selling in the stocks is difficult compared to going short on the stock CFD’s.
In some cases, investors who have a long position in a stock can look to the CFD markets in order to hedge their long positions in the cash markets.
When trading stock CFD’s traders should also note that an overnight rate is applied to the position. This can depend on the stock that you are holding and the direction that you are in. In most cases, long positions in stock CFD’s attracts negative overnight or vice-versa. This is also referred to as a holding rate.
In conclusion, stock CFD’s have their own pros and cons. At the end of the day, it is up to the trader to know why they want to trade the stock CFD’s and whether it is the better solution compared to other ways of trading the underlying instrument.