CFD trading is a way of participating in various financial markets without owning the underlying assets. When you buy shares, you take direct ownership of those shares, while CFD trading lets you predict share prices without having to own them.
- You never own the underlying asset when trading CFDs, including stock CFDs
- Your broker owns the physical shares when you trade CFDs
- In practical terms, your CFD trade amounts to a bet with your CFD broker on the price movement of a company’s shares
The simple answer is no, you don’t own the stock in CFD trading. You are speculating on its price movement, agreeing to pay the difference in price of the underlying asset between when the contract opens and closes. There is more to it than that, however, and this page delves a little deeper into the sometimes complex world of share CFD trading.
What are Stock CFDs?
A CFD (Contract for Difference) is a financial derivative that allows traders to speculate on the price movements of an underlying asset, in this case, stocks. Unlike traditional stock trading, CFDs do not involve the actual ownership of the underlying asset. Stock CFDs come with unique features such as leverage, enabling you to control a larger position size with a smaller capital investment. Additionally, CFDs allow for short selling, providing opportunities to profit from falling stock market prices and not just rising CFD stock prices.
Who owns the shares in a CFD trade?
When you trade shares via CFDs, your CFD broker owns the physical shares. This is because a CFD is what they call a swap trade. You have swapped the physical shares for a paper contract, which gives you the right to 100% of the profits and losses but not the full ownership of the shares.
This also means that the CFD trader will have no right to vote at the company’s AGM or on other company-related matters. Some companies also offer shareholder perks such as reduced flight prices or discounts in their stores, and again, the CFD trader will not be entitled to these. However, as the CFD trader, you will be entitled to take up a company Rights Issue and receive dividends or have to pay them if you short the shares – see how CFD dividends are handled.
Interesting point regarding voting rights
Often, you’ll hear about certain entrepreneurs using CFDs to build a stake in a company with a view to joining the board or using their shareholding to influence general company policy, perhaps pushing for asset sales or a general company re-organisation.
In these types of situations, the CFD holder will have negotiated a special deal with their broker, giving them full voting rights for their CFD position. So, although they don’t physically own the shares, they control the voting rights.
CFDs and Dividends
Dividends are payments made by companies to their shareholders out of profits. They’re a way for you to receive a portion of the company’s earnings as an investor. Often issued as cash payments if you own the underlying share, dividends can also be paid out to investors in the form of additional shares.
In traditional stock ownership, investors earn dividends by holding shares for a certain period. The amount received depends on the company’s profitability and its dividend policy.
As a stock CFD trader, the dividend landscape differs. Since you don’t own the underlying asset, receiving dividends as traditional shareholders do is not straightforward.
Dividend Payments for stock CFD’s
In CFD trading, you don’t own the actual shares, and thus, you won’t receive dividends in the traditional sense. However, the impact of dividends on the underlying asset can influence CFD prices.
Some brokers adjust CFD prices to account for dividends, while others may offer cash adjustments. It’s essential that you understand your CFD broker’s policy regarding dividends.
One important factor to remember as a CFD trader, is that if you are short a CFD, you will be charged a dividend.
Whether you are paid or have to pay a dividend, this will often be automatically reflected in your account by your CFD provider.
When are dividends paid?
Dividends are booked on the ex-dividend date and paid on the payment date.
Indeed there are many dates to remember, including the record date and the declaration date. While all these dates might sound confusing, if you are an existing shareholder of a company’s stock, you’ll receive notification, typically by mail, when the company declares a dividend payment and what these dates are.
E.g. If you hold a long position in shares with CFDs, and hold them the day before the ex-dividend date, then you become entitled to a payment equivalent to the amount of the dividend.
Costs of CFD Trading
Unlike traditional stock trading, CFDs typically involve lower transaction costs. When trading share CFDs you will, however, be subject to some costs. When share trading CFDs, common costs include a commission and the spread (I.E. the difference between the bid price and the offer price at the time you trade).
In addition, there are other costs specific to share trading CFDs which we have outlined below.
Capital Gains Tax (CGT)
Capital gains tax (CGT) is a tax on any profits you make from financial transactions (or non-inventory assets). Essentially, if you trade a financial market and make a profit, you’ll most likely have to pay CGT on those earnings (although some financial transactions, such as spread betting, are free from CGT).
When you trade CFDs in the UK, you will pay capital gains tax (CGT) on your profits. However, you can offset your losses against them to lower your bill.
Pros and Cons of Trading Stock CFDs
Like any financial instrument, there are advantages and disadvantages of trading stock CFDs. It’s important to be aware of both so you can be aware of the potential risks and, on the flip side, take advantage of the associated benefits of stock CFD trading. We have outlined both the pros and cons of trading stock CFDs below.
What are the advantages of stock CFD trading?
Stock CFDs provide flexibility in terms of trading strategies. Whether you are interested in day trading, swing trading, or long-term investing, CFDs offer a versatile approach to suit different trading styles. We have explained these trading styles in more detail below.
Compared to traditional share trading, CFDs typically involve lower transaction costs, as highlighted above. This makes them an attractive option if you want to maximise your returns without incurring high fees. One major cost you are exempt from in the UK is stamp duty, which is a tax that usually applies to traditional equities, usually calculated as a percentage of the total value of the asset.
Leverage (or margin trading)
Stock CFDs are leveraged assets, meaning you only put down a smaller initial outlay (or margin deposit) to open your position. With leverage, you can get a much larger exposure to the market than the amount you deposited to open the trade. While leveraged products, like CFDs, amplify your potential profits, they can also, conversely, amplify your losses.
Stock CFDs allow you to diversify your portfolio across various assets without the need for significant capital. This is due to the leveraged nature of CFDs in general. This diversification can help you manage risk and enhance your overall portfolio stability.
Go Long or Go Short
When stock CFD trading, because you’re speculating on price movements using derivatives, you can ‘go long’ and ‘short’ whereas when trading stocks, it’s not as simple. A lot of brokers don’t offer the ability to short-sell traditional shares and the ones that do, it’s a much more complicated process than for stock CFDs.
What are the advantages of stock CFD trading?
As with any form of trading, stock CFDs are exposed to market risks. Fluctuations in the price of the underlying asset, called volatility, can result in both profits and losses. There are also times when the market is particularly volatile, such as during a major economic data announcement like a Central Bank interest rate decision, so it’s important to be aware of these market risks so they don’t take you by surprise.
While leverage can amplify profits, as mentioned above, it also magnifies the potential for losses. This is because you are trading with a smaller initial outlay than the total value of the stock CFD. As a stock CFD trader, it’s important you exercise caution and employ risk management strategies when trading stock CFDs with leverage. In the UK, the financial regulator is the Financial Conduct Authority, which limits your leverage to between 2:1 and 30:1 for CFD products, depending on the volatility of the underlying asset.
Fees and Costs
Stock CFDs, while generally having less transaction costs than traditional share trading, do incur some costs. These include commissions, spreads, financing costs, and capital gains tax on any profits made. It’s important to be aware of these costs, which can impact your overall profitability.
Strategies for Trading Stock CFDs
Whether you are a beginner or an experienced trader, it’s still important to come up with a trading strategy to mitigate the potential risks of stock CFD trading and keep you on track. What trading strategy you use always comes down to personal preference and your trading style. We’ve highlighted some common trading strategies below.
Day trading involves making short-term trades within a single trading day. It requires quick decision-making and a deep understanding of market dynamics.
Swing trading aims to capture “swings” in the market, typically holding positions for a few days to weeks. This strategy requires a blend of technical and fundamental analysis given that is a short to medium-term trading strategy. Technical analysis involves analysing historical price movements using charts and fundamental analysis is a method of measuring a stock’s real or ‘fair market’ value.
While often associated with short-term trading, stock CFDs can also be used as a long-term investment. You can take advantage of trends using technical analysis over extended periods, aligning with your investment goals. It’s important to note that when holding a stock CFD position for an indefinite period you will incur additional charges including overnight financing costs.
In conclusion, stock CFDs offer a dynamic and accessible avenue for traders to engage with financial markets. Whether you’re a seasoned investor or a novice trader, understanding the advantages, risks, and strategies associated with stock CFDs is essential for making informed decisions.
- When dealing with CFDs, such as stock CFDs, you do not possess the underlying asset.
- Your CFD broker is the owner of the actual shares during CFD trading.
- In practicality, your CFD trade essentially constitutes a speculation with your CFD broker on the price direction of a company’s shares.
What is a CFD stock?
A CFD stock is a derivative that enables you to trade the price movements of an underlying stock market as a CFD without owning the underlying stock itself. CFD stock trading is the same in principle as traditional stock trading with some key differences including leverage and tax implications.
Can you trade stocks with CFDs?
Yes, if you want to trade stocks you can either buy the underlying share (or physical share) or trade stocks via CFDs. As mentioned above, CFDs are leveraged products, unlike traditional stocks themselves.
When you buy CFDs do you own the underlying asset?
No, when you buy CFDs you are simply speculating or taking a position on the price movement of underlying assets without actually owning those assets. When you buy a traditional share, however, you are buying the underlying asset.