CFDs vs Stocks

Stock Trading or CFD Trading? Which is best?

When contracts for difference (CFDs) first launched in Australia there was quite a bit of apprehension from traders in a product that had so much leverage with trading costs so low. For many share traders and options traders the deal just seemed too good to be true.

Keeping in mind when CFDs first launched you could trade the TOP 200 ASX shares at 5% margin with NO BROKERAGE. Without pointing out the obvious, the advantages for CFD trading versus stock trading were very clear:

• Zero Brokerage
• Access to the top 200 ASX Shares
• 5% margin or up to 20 times leverage
• Free trading platform

Unfortunately for traders the zero brokerage whilst trading CFDs didn't last that long and nowadays the common brokerage levels for CFD providers is around 0.1% or $10 minimum.

So is stock trading or CFD trading the way to go?

Let's get straight to the point. If you have little trading capital (from $1,000 to $10,000) then your choices for stock trading can be somewhat limited. The reasons for this are pretty straight forward.

If you make a $2,000 trade with someone like Etrade, where your share brokerage is $65.90 incl GST (as of writing) for a complete trade, it will eat significantly into your trading profits. Just to break even, your $2,000 position has to go up 3.30%. Now that may not seem a lot initially but what if you are doing a number of trades in a month? Each position now has to gain 3.30% just to break even.

If you have less than $10,000 starting capital the following example may be useful.

CFD Account with zero leverage to compare a share trading account.

Now consider two different share trading accounts charging brokerage of either $65.90 or $39.90 round trip.

At what point do you break even on CFD Financing?

In the example above you can see it costs approximately $0.51 per day to hold a $2,000 position overnight when trading CFDs. Therefore if you get charged $65.90 to get in and out (round trip) then your break even point with your CFD trade is 90 days.

If you get charged $39.90 for a round trip then your break even point with your CFD trade is 39 days. So if you are a shorter time frame trader then the cost savings alone with CFD trading put them way in front of stock trading.

So before we even introduce leverage into the comparison, most shorter time frame stock traders would be better off making the switch to CFD trading.

Accessing greater opportunity

Another point to consider with your $10,000 CFD account is if you decide to use CFD leverage which is the major benefit behind CFD trading. The beauty of Contracts for Difference (CFDs) is that with your $10,000 cash in your account you could now access say 2-3 times that amount and take total positions equivalent to $20,000 - $30,000 which you can't do with a share trading account. Trading at 2-3 times leverage on your account obviously gives you greater access to more opportunities compared to a stock trading account which has no leverage.

On the other hand, with a CFD account you can usually only access the top 500 share CFDs compared with over 2,600 stocks on the Australian Stock Exchange. So if you like to trade the low cap stocks then a standard share trading account might be the way to go. Having said that there is a CFD provider that gives you Direct Market Access (DMA) on every listed ASX stock – Marketech online CFD trading.

What about Dividends?

CFD trading gives you access to dividends just like you would trading stocks except for one small difference. When trading CFDs you do not get any franking credits on dividends earned. Franking credits (sometimes called imputation credits) are designed to prevent the double taxing of income as the companies paying the dividend have already paid tax on the earnings of the company, so you don't have to.
NOTE: To receive full franking credits when trading shares you do need to hold your position for a minimum of 45 days.

If dividends are a big part of your investment decision making then shares will win you over here.

Link to ASX website on dividends
Link to ATO website on dividends

Short selling

There is simply no comparison here as CFDs win hands down on the short selling front. Unfortunately short selling can only be done with a full service broker when trading stocks. This can be quite restrictive as your full service broker will have to find someone on the other side of the trade in order to borrow the stock plus the trading costs can be quite high.

Conversely, short selling CFDs is incredibly simple. You have access to approximately 200+ share CFDs and margins are normally from 5-30% and there are less restrictions. Keep in mind that CFD providers have to hedge themselves in the physical market from time to time so they have to try and find the other side of the trade too.

On occasions you may try to place a short sale on a share CFD only to find your CFD provider won't allow you. This would normally mean they can't find the other side in order to hedge themselves. This is more prevalent with DMA CFD providers compared to Market Maker models.

Guaranteed Stops

Once again there is a clear winner here in that you cannot place a guaranteed stop when trading stocks, however most CFD providers will allow you to place a guaranteed stop when CFD trading. There are usually restrictions on doing this but at least they are available.

Advantages of CFD trading versus Stock trading

• Low trading costs

• Overnight CFD financing is not a factor if holding positions for less than 40 – 90 days

• Greater access to opportunities through leveraging your trading dollars

• Some CFD providers allow you to trade the full complement of ASX listed stocks

• Access to dividends

• Short selling is available on top 200+ ASX share CFDs

• Guaranteed stops readily available from most CFD providers

Disadvantages of CFD trading versus Stock trading

• Overnight financing will become a factor if holding share trades for more than
  40-90 days

• Most CFD providers only give you access to the top 500 ASX listed stocks

• No franking credits on dividends received

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Disclaimer: Trading Contracts for Difference carry risk where you can lose more than what you start with. View our full disclaimer here.

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