CFDs Vs StockBy Jeff Cartridge | 02 March 2010, 18:04 BST
Many people ask what is the best instrument to trade and the answer to that is dependent on what it is that the trader wants to achieve. Today we will take a look at CFDs vs Stock and weigh up the advantages and disadvantages of each.
Cash, All or Nothing
When buying stock it is necessary to have all of the cash to purchase the stock. While it is possible to reduce this requirement by using margin loans at the very best you will be required to have 30 - 40% of the value of the underlying stock in cash. With CFDs the amount of cash required is as low as 3% for stocks and even less if you are trading indices or currencies. The profit potential when trading CFDs is very large due to the leverage employed and can be 10 - 20 times that available when trading stocks. So for efficient use of capital and profit potential in the battle of CFDs vs Stock, CFDs win hands down.
What Could Possibly Go Wrong?
The other side of leverage is risk as leverage amplifies both gains and losses. The most you can lose when investing in stocks is 100% of your capital, assuming you have not borrowed any money to invest. With CFDs losses can be far larger than 100% of your initial investment, if you do not effectively manage your risk. While it is possible to manage your risk when trading CFDs in the battle of CFDs vs Stock the lack of leverage when trading stock makes risk management much easier with stock.
How Much, The Cost of Doing Business
There are two main costs of trading that can be looked at in the battle of CFD vs Stock. Brokerage will vary depending on who you open an account through, however it is typically lower on CFD versus stock with rates down to 0.08% of the value of the purchase. Interest costs do not apply to stocks, but because CFDs are leveraged, interest charges do apply. The winner here is not clear cut, but the finance charges associated with CFDs could be higher than the additional brokerage paid when trading stock, depending on how long the position is to be held.
Tax Free Profits?
One of the reasons that CFDs were originally developed was to get around stamp duty that was payable in the UK on stock purchases. CFDs were exempt from stamp duty. In Australia the capital gains tax regime does not apply to CFDs with all gains or losses treated as income. CFDs are not eligible for a capital gains discount if held for 12 months or more and do not receive franking credits on dividends. So there are some tax advantages to stocks. Tax advantages vary dramatically from country to country so it is hard to call a definitive ruling here in the battle of CFDs vs stock.
CFDs vs Stock Conclusion
In conclusion in the battle of CFDs vs stock there is no clear winner, it will depend on what is most important to you. CFDs offer more upside potential with less capital investment due to the leverage available. The risk associated with CFDs is higher because of the same leverage, so managing risk is more important to the CFD trader than the stock trader. From a cost perspective CFDs may have an advantage due to low transaction costs, but this advantage can disappear if CFDs are held for long periods of time as interest charges accrue. In conclusion I personally like the access to leverage that CFDs provide and I actively manage my risk to control the impact of leverage on my portfolio.
Jeff Cartridge is the author of Supercharge Your Trading with CFDs and the creator of LearnCFDs.com Discover the 7 most Critical CFD trading tips and 2 of the most common CFD Trading Strategies CFD Trading Tips
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