Contracts for difference

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9. Comparison of CFDs to share investing

Most investors start out in the stock market by owning individual shares or equity funds. Now is a good point to step back a pace, and compare the respective merits of CFDs vs shares.

Advantages of CFDs compared to shares

• There is no stamp duty to pay
• Broker commissions are much lower
• Trading on margin allows you to leverage your capital and increase return on investment
• It is easy to go short
• Settlement is simple and immediate
• You can trade CFD indices and baskets of shares

Disadvantages of CFDs compared to shares

• Since you don't own the shares, you don't have voting rights
• Trading on margin cuts both ways: it magnifies losses as well as profits
• The financing costs of CFDs make them expensive in the long term
• You have to demonstrate experience in both equities and margin trading before your broker will allow you to trade CFDs

As far as the disadvantages are concerned, it is worth paying close attention to the financing costs (interest charges) you have to pay when you hold a long CFD. If the reason you are trading CFDs in the first place is that you want to avoid stamp duty, you don't want to run up interest charges that exceed the stamp duty you would have paid. But at what point will that happen?

• If you buy a CFD equivalent to £10,000 of shares, the stamp duty that you would have paid if you had bought the shares would be 0.5% x £10,000 = £50.
• The daily financing costs of holding the CFD, at a 6.5% interest rate, will be £1.78 (0.065 x £10,000/365).

On that basis, the crossover point, when accumulated interest charges overtake stamp duty, will come after 28 days. So:

• If you keep a long CFD open for less than 28 days, the financing costs are lower than the stamp duty.
• If you keep a long CFD open for more than 28 days, the financing costs are higher than the stamp duty.

The crossover point will occur earlier if interest rates rise above 6.5%, and occur later if they fall below 6.5%.

Click here for a quick, visual, presentation of the differences between ordinary share investing, spread betting, and CFDs.

1. What are CFDs? 2. The benefits of CFDs 3. Initial margin 4. Variation margin 5. Commission costs 6. Interest payments 7. Dividends 8. Example of a long and short trade 9. Comparison of CFDs to share investing 10. Comparison of CFD trading to spread betting 11. Types of order 12. Stop losses 13. Strategies: Pairs trading 14. Strategies: Hedging an equity portfolio 15. Opening an account with a broker 16. Conclusion

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