What are Stock CFDs?

While the majority of first-time investors prefer to purchase shares outright, an increasing number of people are opting to buy and trade stock CFDs instead  Although you won’t be entitled to dividends, this does present a number of benefits. This includes the ability to apply leverage, short-sell a company, and trade with much tighter spreads.

In this guide, we explain the ins and outs of what stock CFDs are and how they work. This will allow you to make an informed decision as to whether or not the asset class is right for your long-term investing goals.

What are Stock CFDs?

First and foremost, we need to discuss what CFDs are. Contracts-for-differences – or simply CFDs, allow you to speculate on a financial instrument without you owning the asset. Instead, you will be speculating on whether you think the asset will go up in value, or down. As CFDs are facilitated by online trading platforms, they can track virtually every asset class imaginable.

This includes stocks and shares, indices, gold, oil, natural gas, and even cryptocurrencies. For example, let’s suppose that BP shares are currently priced at 336p on the London Stock Exchange. If you were to trade BP stock CFDs, the price would also be 336p – less a very slight variation. Then, if the price of BP shares increases by 2.4%, the stock CFD will follow suit.

Crucially, stock CFDs – and all CFDs for that matter, are simply tasked with tracking the real-world price of the underlying asset. It is important to note that stock CFDs do not generate dividends. This is because you do not own the underlying asset, so it’s only capital gains that are in play. That is to say, you will make money from stock CFDs if you correctly predict its future value.

Trading Stock CFDs vs Buying Shares

How do Stock CFDs Work?

Stock CFDs will simply track the real-world price of the shares that you wish to gain access to. So, if the price of shares goes up on the London Stock Exchange, as will the stock CFDs. Similarly, if the share price goes down, as will the stock CFDs.

Here’s an example of how a stock CFD trade would work in practice.

• You are expecting Barclays to publish better-than-expected results in its quarterly earnings report
• The price of Barclays shares on the London Stock Exchange is 115p
• You decide to use a CFD broker to benefit from tighter spreads and lower fees
• The CFD broker offers a ‘buy’ price of 115.2p and a ‘sell’ price of 114.8p
• You decide to place a buy order worth £500
• Your prediction on Barclays reporting positive results was correct as its price goes up by 5%
• As you are now able to sell your stock CFDs at 120.9p, you decide to cash in your gains
• On a stake of £500, your 5% gains amounts to a total profit of £25

As you can see from the above, when the price of Barclays shares increased by 5% on the London Stock Exchange, as did your stock CFDs. The key difference is that you were able to benefit from a low-cost investment that is condusive for short-term gains.

Why Consider Stock CFDs?

So that begs the question – why bother with stock CFDs if you do not own the asset? Why not just purchase traditional stocks from a share dealing platform? Let’s find out!

Short-Selling

One of the main benefits of opting for stock CFDs as opposed to traditional shares is that you will always have the option of short-selling. For those unaware, short-selling means that you think the value of a company will go down. Ordinarily, conventional share dealing platforms only allow you to ‘go long’ – meaning that you are buying the stocks because you think the company will increase in value.

However, short-selling is the complete opposite. That is to say, if the value of the shares goes down, you will make a profit.

For example:

• You think that the airline industry is in for tough time – as per the coronavirus pandemic
• As such, you decide to place a sell-order on Ryanair CFD stocks
• You invest a total of £500 into the sell order
• A few weeks later, Ryanair stocks have gone done by 15%
• You decide to close the position to lock in your profits
• On a stake of £500, this represents a profit of £75 – less overnight financing fees

Crucially, when you use a specialist CFD trading platform, you will have the opportunity to short-sell thousands of companies at the click of a button.

Leverage

On top of short-selling, stock CFDs are perfect if you have a higher appetite for risk. This is because you will be able to apply leverage on your trade. For those unaware, leverage allows you to trade with more money than you have in your trading account. Expressed as a multiple, your chosen leverage limit will amplify your stake.

For example:

• Let’s suppose that you want to buy some Royal Mail shares
• You only have £250 in your broker account, so you decide to apply leverage of 3x
• This means that you are actually buying £750 worth of stock CFDs
• As such, any profits or losses that you make are subsequently multiplied by a factor of three

It is important to note that leverage is not for the faint-hearted, nor should it be utilized by newbie traders. Instead, leverage can very quickly amplify your losses – so tread with extreme caution. In fact, this is why UK and European traders are bound by the regulations imposed by the European Securities and Markets Authority (ESMA).

In a nutshell, ESMA rules dictate that retail traders are limited in the amount of leverage they have access to. In the case of stock CFDs, this stands at 5x. At the upper end of the rules, major forex pairs like USD/GBP and EUR/USD can be traded at 30x. Cryptocurrencies like Bitcoin are capped at just 2x. Ultimately, this is to protect newbie traders from losing more than they can afford.

Tighter Spreads and More Competitive Fees

On the one hand, the process of buying and selling traditional shares has never been easier. You simply need to log in to your UK stock broker account, deposit some funds, and then choose which shares you want to buy. With that being said, there is much that goes on behind the scenes that can make the process somewhat costly.

This typically includes commission-free trades and tight spreads. The reason for this is that the underlying asset does not actually exist. Instead, the stock CFDs are merely tracking the real-world price of the shares!

Access International Stock Markets

When you use a traditional share dealing platform, you might find that you only have access to a limited number of equities. This might include major firms on the London Stock Exchange – and possibly the New York Stock Exchange and NASDAQ. However, what about stocks and shares listed on less liquid markets like Canada, Australia, Sweden, and France?

The key problem for traditional brokers is that they need to actually source the shares on your behalf. This is because when you make an investment, you are the beneficial owner of the shares.

On the contrary, when you use a stock CFD broker, you will typically have access to thousands of companies across dozens of stock exchanges. Once again, this is because of the ease in which CFD products can track real-world assets. As a result, you can create a highly diversified portfolio of stock CFDs from several countries at the click of a button.

What are the Drawbacks of Stock CFDs?

As great as stock CFDs can be for obtaining leverage and short-selling companies, they do come with a number of drawbacks that you need to consider before taking the plunge.

No Dividends

As we briefly noted earlier, stock CFDs do not entitle you to dividends. One the one hand, this wouldn’t be an issue when investing in companies such as Amazon, Apple, Twitter, Uber, Facebook, and many others – not least because they are not dividend-paying firms.

On the other hand, a significant number of PLCs do in fact pay dividends, meaning that you are missing out on the income that traditional shares yield. A prime example of this is BP, which paid a mouth-watering dividend yield of 10.2% in 2019.

Not Suitable for Long-Term Investors

An additional drawback that you need to consider is that stock CFDs are not conducive for a long-term buy and hold strategy. The overarching reason for this is that CFDs are leveraged products. In fact, even if you do not apply leverage to your stock CFD trades, you will still need to pay a fee in the form of ‘overnight financing’.

In a nutshell, overnight financing is like an interest charge that you need to pay for each day that you keep the position open. This might not be an issue in the short-to-medium run – but, paying overnight financing fees for a number of months is going to start becoming very costly. This is why stock CFDs are best suited for those of you that wish to trade on a short-term basis.

More Susceptible to a Brokerage Collapse

When it comes to safety, you need to consider the impact of a brokerage collapse. In the case of a traditional share dealing platform, this wouldn’t be of much as an issue. The reason for this is that were the broker to cease trading, you would still own the shares outright. As such, they would simply be transferred to another broker.

At the other end of the spectrum, a CFD broker collapse could potentially be more costly. As the shares do not exist, you are banking on the platform having sufficient capital to pay you out. With that being said, there are strict rules in the UK CFD space concerning brokers.

At the forefront of this is a requirement to hold an FCA license. In doing so, all UK-based CFD brokers must keep client funds in segregated bank accounts. In theory, this should keep your money safe in the event the worse happens.

How do I Trade Stock CFDs?

If you like the sound of stock CFDs and you want to get started today, we are now going to guide you through the step-by-step process. This includes finding a CFD trading platform that meets your needs, opening an account and depositing funds, and placing your first stock CFD trade.

Step 1: Join a CFD Broker

Your first port of call is to join a CFD broker. There are a number of metrics that you need to look out for prior to taking the plunge – such as:

• Is the broker regulated by the FCA?
• What stock CFDs will you be able to trade?
• How much does the broker charge in trading commissions, fees, and overnight financing
• Does the broker offer competitive spreads?
• What payment methods does the broker support?
• Are there any minimum requirements on deposits, account balances, or withdrawals?

Finding a suitable UK-based CFD broker will require you to perform your own research. If you don’t have time to do this and you want to get started today – below you will find out three best-rated stock CFD trading platforms of 2020.

1. Plus500 – Commission-Free Stock CFD Trading Platform

Plus500 is a specialist CFD provider – meaning that you will not have the option of buying traditional shares. You will, however, have access to more than 2,000 stock CFDs. This includes heaps of stock exchanges of all shapes and sizes. Best of all, Plus500 does not charge any trading commissions when you enter buy and sell positions on stock CFDs.

Instead, it’s only the spread that you need to pay. Don’t forget, overnight financing fees will apply if you keep the position open past market hours – as this is industry standard. Nevertheless, Plus500UK Ltd is authorized & regulated by the FCA (#509909). Its parent company is also a PLC on the London Stock Exchange,

In terms of getting started, it takes just minutes to open an account, and minimum deposits start at £100. You can fund your account with a UK debit/credit card, bank account, or e-wallet. All deposits are fee-free, as are withdrawals. Finally, Plus500 offers a mobile trading app on both iOS and Android – which is ideal if you plan trade stock CFDs on the move.

Pros

• Commission-free CFD platform – only pay the spread
• Thousands of financial instruments across heaps of markets
• Retail clients can trade stock CFDs with leverage of up to 1:5
• You can short-sell a stock CFD if you think its value will go down
• Takes just minutes to open an account and deposit funds

Cons

• CFDs only
• More suitable for experienced traders

72% of retail investors lose money trading CFDs at this site

3. IG – Trusted UK Stock and CFD Trading Platform With Competitive-Fees

IG offers both share dealing services and CFDs. In fact, it also offers a fully-fledged spread betting facility. This is something worth considering, as you will be able to trade stock CFDs and avoid paying capital gains tax on your profits. Either way, IG charges a variable trading commissions structure that will depend on the stock market you wish to access.

For example, trading UK stock CFDs will cost you 0.10% in commissions, which is calculated against your total order size (£10 minimum). If its US-listed stock CFDs you’re after, this comes at a flat-fee of $0.02 per share ($15 minimum). With more than 8,000 shares listed across dozens of exchanges, it’s best to check the specific commission before trading.

In terms of the specifics, IG was first launched in 1974 and holds several licenses – including that of the UK’s FCA. It accepts debit/credit cards and bank transfer, albeit, you will need to meet a £250 minimum deposit. Moreover, Visa and MasterCard payments are charged at 1% and 0.5%, respectively.

Pros

• Trusted UK broker with a long-standing reputation
• Good value share dealing services
• Leverage and short-selling also available
• Spread betting and CFD products
• Access to UK and international markets
• Great research department

Cons

• Minimum deposit of £250
• US stocks have a $15 minimum commission

The Verdict

In summary, stock CFDs should be viewed as an alternative to traditional shares if you are looking to place more sophisticated trades. Whether it’s applying leverage, short-selling, or gaining access to difficult-to-reach markets – CFDs do tick a lot of boxes. On the flip side, you need to remember that you won’t own the underlying stock.

This means that there will be no entitlement to dividends, so you can only make money through capital gains. Ultimately, if you do want to give stock CFDs a go, just make sure that you start off with really small stakes – and that you have a firm grasp of the risks.

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