CFDs on shares – CFDs on stocks – are CFDs with shares as their underlying assets. This is one of the least popular categories of CFD among retail traders. However, it’s possible for many traders to integrate these instruments into their trading strategies if they can understand some of their key features.
Shares and stocks
A share basically represents a portion of ownership of a company. If you buy shares in a company, it means you have a claim to the company’s assets and earnings. Depending on the type of shares you own, you might be given the right to vote in shareholders’ meetings. The more shares you have, the greater the level of control. However, this is not a very relevant driver for the average investor.
For the purposes of this introductory article, ‘equities’, ‘shares’ and ‘stocks’ are all the same thing. As far as the average retail trader of CFDs is concerned, there is no difference between ‘CFDs on shares’, ‘CFDs on stocks’ and ‘equity CFDs’. All three terms are interchangeable.
Why do companies sell shares?
The main reason that companies sell shares is that they want to raise money. Selling shares is one way for companies to fund their assets. Another is to take out loans. The two options have different advantages and disadvantages.
When a company funds its assets by issuing shares, it doesn’t need to pay interest the way it would if it borrowed. Investors receive their returns both in dividends and appreciation of capital (i.e. increases in the prices of the shares they hold) if the company is successful. Issuing shares is often called ‘equity financing’.
There is a variety of risks taken by anybody who invests in a company. Shareholders can only make money if a company is successful. A lot of money could be lost if it’s not and a shareholder could lose all of their investment if the company goes bankrupt.
A range of other complexities affect deliverable shares. These include classes of share: typically larger companies will issue class A, B and sometimes C shares. The prices of the classes are different because they offer different benefits.
CFDs on stocks
In the same way as any other type of CFD, the key difference between a CFD on a stock and an actual stock is that the CFD does not involve any ownership of the underlying. CFDs on stocks are not traded on exchanges. Buying a CFD on a stock does not give you any real stake in the company.
The structure of Exness’ CFDs on stocks is different from other CFDs on stocks/shares. All CFDs on shares are based on the price of an underlying share. The basic difference with Exness’ CFDs on stocks is how prices reflect announced dividends and adjustments for dividends.
In addition to this, Exness’ CFDs on stocks are not subject to commissions plus spreads as standard for most CFDs on shares. Instead, traders pay either a commission or a spread depending on the type of account they’re using.
Why trade CFDs on stocks when you can just buy shares?
Leverage is one of the main reasons that CFDs in general are appealing to many traders, and CFDs on stocks are no exception to this. The margin requirements for trading CFDs on stocks are typically around 5% of the nominal value of the orders made.
This means that experienced, successful traders will typically make more money daytrading CFDs on stocks than deliverable shares. Conversely, inexperienced and reckless traders will usually lose much more money trading CFDs on stocks than they would buying deliverable shares.
It can be convenient for traders to have access to CFDs on stocks in the same platform (MetaTrader 5) as other types of CFD. The availability of forex, metals, energies, indices, cryptocurrencies and stocks in one place can make it easier to use diversification as a strategy for managing risk if a trader considers this appropriate.
Perhaps the most important reason for trading CFDs on stocks is that buying and selling CFDs are functionally the same. In a situation of falling prices of shares during a correction or a significant economic crisis, traders of deliverables can’t sell things they don’t own. With CFDs though you can sell under basically the same conditions as buying.
Trading shares downward is often cited at the origin of CFDs and traditionally one of their most popular functions. Since the 1990s, large investors in deliverable shares have attempted to hedge by selling CFDs on stocks during down markets. This approach came much more into focus for retail traders during and after the Global Financial Crisis in 2007-2008.
Key disadvantages of CFDs on stocks
Major shares historically go up in price over time. The most common way to invest in deliverable shares among retail investors is to buy them when their prices are relatively low (i.e. having corrected or retraced from recent highs) and hold them for a long time, usually at least several years. Investors then sell these shares when they retire or want to reconfigure their portfolios into less risky assets (such as traditional savings) in later life.
This approach just isn’t practical for CFDs on stocks. It costs money (swap) to keep an order open for a CFD on a stock overnight. Even after less than a year, costs can rise considerably. This reflects the fact that CFDs are designed for trading, not investing or buy-and-hold strategies.
As with any other type of CFD, leverage can be as much a bane for new traders as it is a boon for experienced traders. Note that 1:20 leverage for CFDs on stocks is much lower than the maximum for currencies (1:2000 and even Unlimited Leverage is available for forex). This is because the average range of many shares is much higher than comparable forex pairs, so it’s much easier for a new trader to lose a lot of money trading shares with leverage. AAPL, for example, typically moves much more every week than EUR-USD.
How to use CFDs on stocks
Some people would reject CFDs on stocks as pointless gimmicks. However, the fact is that CFDs on stocks have fundamentally different purposes from deliverable shares.
Apart from selling CFDs on stocks during down markets, some traders like to trade in either direction before companies release their earning reports. While risky, this can allow experienced traders to trade larger volumes than they could with deliverable shares, so the results are larger.
Ultimately, it’s wise to dust off your demo account whenever you’re considering trading a new type of CFD. Exness’ CFDs on stocks are available on MT5 for demo and real accounts plus Exness’ platform. Why not open some charts and check them out?
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Which of these is one of the main differences between deliverable shares and CFDs on stocks?CorrectIncorrect
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CFDs on stocks pay dividends to traders who buy them.CorrectIncorrect
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