CFD vs Stocks: What’s the Best Investment?

Read on to find out about the differences between CFDs and stocks,

Updated: May 20, 2024
Matt Crabtree

Written By

Matt Crabtree

CompareBanks is reader-supported. When you click through some links on our site, we may earn an affiliate commission. Learn more

Investing can be tricky, especially when there are so many options available to allocate your capital. Two of the most popular options are CFDs and stocks, each with their own unique advantages and risks.

While stocks are often seen as a safe and simple choice, CFDs offer a higher level of flexibility and leverage.

So, which one should you choose? This article will take a closer look at the differences between CFDs and stocks, weigh up their pros and cons, and help you decide which option is the best fit for your financial goals.

CFD vs Stocks

What are CFDs?

These are financial instruments that allow traders to bet on the price movements of an underlying asset, like stocks or commodities, without actually owning the asset.

When you trade CFDs, you're basically making a deal with a broker. The deal specifies the opening and closing price of the asset, and your potential profit or loss is based on the difference between the two prices.

If you think the asset's price will go up, you can go long, and if you think it will go down, you can go short.

CFDs have some advantages over traditional trading, like the ability to trade in both rising and falling markets.

You can also open large positions with just a small amount of capital thanks to high leverage. But remember, this also magnifies your potential losses, so be careful.

What are Stocks?

Now, let's talk about stocks. Stocks are essentially just a way of saying you own a piece of a company. When you purchase stocks you become a part-owner of the company and can trade them on stock exchanges like the NASDAQ or the NYSE.

There's two main kinds of stock: common and preferred. Common stocks give you voting rights and a share in the company's profits, while preferred stocks usually offer a fixed dividend but no voting rights.

Traditional share trading can be effective in obtaining long term wealth, but keep in mind that stocks can be volatile and their prices can swing a lot based on economic and political events.

So, it's crucial to do your research and diversify your portfolio to manage risk.

In summary, both CFDs and stocks are popular financial instruments with different benefits and risks. Just remember to do your homework and understand the risks before you start investing.

Trading CFDs: Pros and Cons

Pros of Trading CFDs

High Leverage Potential ✔️

CFDs offer high leverage potential, which means that traders can open larger positions with a smaller amount of capital. This can result in bigger profits than traditional trading. However, this doesn't make CFD trading cheaper as high leverage also means high risk.

Make sure you're exercising caution when using margin for stocks trading or on a CFD broker to avoid losing money rapidly.

Ability to Trade on Both Rising and Falling Markets ✔️

Regardless of whether the market is going up or down, traders can profit from the price movements of underlying assets.

This is particularly useful in volatile markets, where traditional trading can be fairly risky.

Greater Liquidity and Flexibility ✔️

Because of how commonly traded these assets contracts are, traders can open and close positions quickly with no need to consider stock exchange opening hours. Additionally, CFDs can be traded on a wide range of markets, giving traders greater exposure to global financial markets.

Cons of Trading Stock CFDs

Risks and Potential Drawbacks ❌️

As with any form of trading there are a few pitfalls that can happen when making a CFD trade, such as the potential for liquidation with irresponsible leverage.

Hidden Fees and Charges ❌️

CFDs often come with hidden fees and charges, such as financing costs, overnight fees, and commissions. In addition to having to pay capital gains tax, These fees can eat into profits and must be factored into trading strategies.

Regulatory Risks ❌️

CFD trading is subject to regulatory risks, as regulations differ from country to country. For example, the Commodity Futures Trading Commission has banned them in the United States.

As an investor, make sure you're trading with a regulated broker and understand the regulations that apply to them.

Investing in Stocks: Pros and Cons

Pros of Stock Trading:

Ownership of a Stake in a Company ✔️

Investing in stocks translates to having a say in the company's decision-making process and being entitled to a portion of its profits.

Moreover, if the company experiences growth, the value of your investment may appreciate, and you may also receive dividend payments as a reward for your investment.

Potential for Long-Term Growth and Dividends ✔️

In general, this is a long-term game. While short-term fluctuations are common, the stock market has historically shown an upward trend – you don't need an advanced trading strategy to see that.

As companies grow and become more profitable, their stock prices can rise, potentially providing investors with significant long-term gains. Additionally, many (but not all) companies pay out dividends to their shareholders, providing an additional source of income.

Lower Levels of Risk Compared to CFDs ✔️

CFDs are a popular alternative to investing in stocks, but they come with much higher levels of risk unlike stocks as your potential loss is limited to the amount you invest.

Cons of Stock Trading

Limited Leverage Potential ❌️

One of the biggest limitations of investing in stocks is that you are limited in your ability to leverage your investments. This means that you cannot use borrowed funds to increase your investment. While this can be seen as a disadvantage, it also means that your losses are limited, and you are not subject to margin calls, which can lead to substantial losses.

Fewer Trading Options ❌️

Unlike other financial instruments, such as futures and options, investing in stocks offers fewer trading options. This can limit your ability to hedge against potential losses or to speculate on the market.

Additionally, stock prices may be subject to market manipulation, which can be a significant risk for investors.

Risk vs Reward: CFDs vs. Stocks

Analysing The Level of Risk Involved in Both CFDs and Stocks

As CFDs are a form of derivative trading, the level of risk is generally much higher and you can actually lose more than your initial investment if you get a margin call.

With stocks, the level of risk is generally lower but there's still a risk involved since the stock market can be unpredictable and a share price can be volatile.

Comparing The Potential Rewards & Returns of Both Options

CFDs have the potential for higher returns than stocks, but they're typically used for short-term gains.

This makes them a popular choice primarily for day traders and those looking for quick profits. However, this short-term approach means that the potential for long-term gains is limited.

Stocks, on the other hand, offer the potential for both short-term and long-term gains. Investing in high-quality companies with strong fundamentals and consistent growth can lead to significant gains over time.

Trading Strategies for CFDs and Stocks

Outlining the Best Trading Strategies for CFDs and Stocks

Before diving into specific trading strategies, it's crucial to note that both CFDs and stocks require a solid understanding of technical and fundamental analysis.

Technical analysis involves studying price charts to identify patterns and trends, while fundamental analysis involves analysing a company's financial performance and economic data to determine its “true” value.

CFDs

For CFDs, the best trading strategy is often to use a combination of the two in order to identify short-term price movements. If you decide to take advantage of the leverage capabilities that come with CFD trading, it's paramount you remember to use risk management techniques such as stop-loss orders.

Stocks

It's generally more important to focus on long-term value investing when it comes to trading stocks.

Reading through a company's financial statements, management, competitive position, and industry trends is a great way to identify undervalued stocks with strong growth potential.

This approach is more suited to investors who are looking to hold stocks for several years, rather than traders who are looking to make quick profits.

Due Diligence & Risk Management

When it comes to trading, choosing the right strategy is just half the battle.

To set yourself up for success, you'll want to make sure you're doing your due diligence and managing your risk effectively.

Of course, this entails digging into the nitty-gritty details of the markets and assets you're trading, setting up stop-loss orders to minimise losses, and spreading out your portfolio to avoid putting all your eggs in one basket.

But that's not all. You also want to make sure you have a solid trading plan in place and that you stick to it no matter what. That means setting realistic goals for your profits and losses, and avoiding rash decisions based on emotions like fear or greed.

With a little discipline and smart risk management, you'll be well on your way to trading success.

The Role of Technology in CFDs and Stocks Trading

Tech has transformed the way we live and work, and the world of finance is no exception. In recent years, the development of advanced trading software and tools has sent ripples throughout the market.

The Impact of Technology

Before technology entered the picture, traders would have to rely on their instincts and spend hours analysing data, charts, and news to make informed decisions.

Now, traders have access to real-time information; advanced analytical tools; and automated systems that can help them make faster and more accurate trades.

One of the most significant impacts of technology on CFDs and stocks trading is the democratisation of the market. Online trading platforms and mobile apps have made it easier for individual investors to enter the market and compete with institutional investors.

The rise of social trading has also allowed traders to share their knowledge and expertise with others, creating a more collaborative and accessible trading environment.

How Technology Can Improve Trading Efficiency & Accuracy

Let's have a look at some practical examples of technology in action.

Trading Platforms

Trading platforms, such as MetaTrader and eToro (review), let you do a bunch of things all in one spot, like accessing the market, managing your trades, and charting with technical indicators.

Algorithmic Trading

These are computer programs to automate trading decisions based on pre-set rules and criteria. This method of trading eliminates the need for human intervention, which ultimately means the risk of human error is reduced while improving the accuracy of trades.

Artificial Intelligence

Similarly, AI can analyse vast amounts of data and identify patterns that humans may miss. AI-powered trading systems can use this information to make informed investment decisions which can be highly profitable

Popular Trading Software & Tools For CFDs and Stock Trading

MetaTrader 5

MetaTrader 5 is an all-in-one trading platform giving you all the tools and features you need to become a successful trader. You can use MetaTrader 5 to trade with a huge range of instruments, from foreign exchange and stocks, to derivatives and commodities.

This platform is particularly great for traders who want to take control of their investments, as it gives you access to comprehensive charting, live data feeds, and advanced order types. With MetaTrader 5, you can maximise your profits and minimise your risks.

cTrader

cTrader is another popular trading platform featuring an intuitive user-interface that makes trading easier and more accessible.

They also offer several advanced features such as advanced charting, automated trading strategies, and scalping.

TradingView

TradingView is an online platform offering powerful charting capabilities and market data for a range of financial markets including stocks, cryptocurrencies, commodities, and indices.

You can apply technical analysis and enjoy 24/7 access to the markets, trading beyond the traditional stock exchange hours. It also provides sophisticated tools such as drawing tools, performance indicators, and algorithmic backtesting capabilities.

Lastly, the platform offers an extensive library of data visualisations, allowing users to seamlessly analyse stocks and markets.

Conclusion: Which is The Better Investment?

In conclusion, it is clear that when it comes to CFDs vs. stocks, there is no perfect answer. Whereas CFDs offer greater flexibility and lower costs, stocks provide better access to capital and dividend payments.

Ultimately, the best investment for any individual should depend on their own circumstances and goals.

As a final disclaimer, it's important for you to be aware of the associated risks, as well as thoroughly understand the legal and regulatory implications of the instrument you choose to invest in.

Making an informed decision, based on analysis and research is the key to success in the investment world, no matter what instrument you use to invest your money.

We hope this article has been able to provide helpful insights for both stock and CFD investors. There is no ‘one size fits all’ solution, so take the time to carefully consider what is right for your particular circumstances and needs.

If you have any questions regarding CFDs or stocks, get in touch with a professional to find out what best suits you.

Related Guides:

Related Articles

How to Invest in the S&P 500
The S&P 500 is a powerful barometer for the state of the US economy. It brings...
What Are Socially Responsible Investments?
If we're being honest with ourselves as investors, how morally reprehensible the...
What Are Municipal Bonds?
Whether you're new to investing or a seasoned pro, it helps to know what kinds of...
How to Invest in Whisky
Alternative investments such as whisky can a great way to diversify your portfolio....