Share trading vs share CFDs: What’s the difference, which is right for you?

If you know a little bit about investing, you've probably come across share trading.

Through buying shares, you own a small piece of a company and can also trade with other investors.

But did you know there's another way to access the stock market?

A Contract For Difference (CFDs) differs to share trading as it enables traders to speculate on the future price of an asset without actually owning it.

While share CFDs are a higher risk, higher reward strategy usually reserved for more experienced investors - the democratisation of investing has seen a growing number of retail investors using these products.

But before getting started it is important to do your research to better understand how it all works.

To help, Finder chatted to Axi business development manager Milan Cutkovic about how CFD trading works. There are 50 share CFDs available to trade on Axi, and more coming soon.

What are the perks of CFDs?

CFDs have two major benefits over traditional assets: leverage and being able to speculate on share prices going up or down.

"Share CFDs can have a leverage of up to 5:1 [in Australia], which means that in order to buy shares worth $1,000, you would only have to put up a portion of your funds as margin – in this case $200," Cutkovic explains. "You could use the remaining funds to trade other products. It also gives you the flexibility to speculate on both rising and falling prices."

When trading using leverage, investors are taking a position on whether or not they think a share will increase or decrease over a set period of time. Traders make profits or losses depending on the extent to which the forecast is correct.

Okay, but what are the disadvantages?

One major advantage of share CFDs can also be its biggest downfall.

"Leverage is a double-edged sword and can be dangerous for investors who do not understand its power," Cutkovic continues. "Leverage can amplify both profit and losses, which is why investors should make themselves familiar with leveraged products – which carry a higher level of risk to their capital – before using them."

With CFDs, investors also don't own the shares themselves which can be a good or a bad thing.

"Share CFDs do not provide any shareholder privileges, as no actual buying of the underlying securities occurs,'' Cutkovic explains.

However, in the case of some brokers, including Axi, they will adjust your position to offset changes from dividends.

Also, investors who use CFDs are likely to pay a higher tax rate.

"Depending on your country of residence, there might also be significant differences in tax liability," he said. "Furthermore, with CFD trading your losses could exceed your initial deposit, so you should always check if your broker offers a negative balance protection," he warns.

From March 2021 in Australia, revised rules from ASIC limit losses to the amount of funds sitting in a traders CFD account.

While mandatory in Australia, not all CFD brokers around the world have negative balance protection which potentially leaves investors exposed to heavier losses.

What type of investor could use share CFDs?

Given the structure of the product, short-term investors will likely favour share CFDs over traditional assets.

This is because share CFDs give them more flexibility and the ability to speculate on falling stock prices.

Using the example of a market correction, like we had recently during COVID, Cutkovic explains how investors can benefit from share CFDs.

"For example, an investor who is anticipating a temporary downturn in the stock market might not wish to reshuffle their entire portfolio and rather opt on speculating on a price decline by using share CFDs," he said.

How to get started

Investors can get started trading share CFDs in just a few short steps.

1. Learn how share CFDs work and whether they are right for you. Axi has a free online Share CFDs trading course.
2. Create a plan that includes how much you have to invest, potential investment opportunities and the downsides should your thesis not work out.
3. Open a trading account with a broker, such as Axi.
4. Add funds to your account and open your first position.
5. Monitor and close position.

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