CFDs or real stocks?
Choosing a trading instrument is a rather complicated and complicated process for a novice investor. Lack of systematized information and widespread advertising of various financial instruments by various brokers are often confused and lead to spontaneous decisions. The trader ignores such important factors as personal characteristics, the amount of available capital, risk tolerance, and chooses an instrument that, according to the broker, promises incredible profits with minimal risk.
One of the most well-known and frequently mentioned financial instruments is shares. By definition, a share is a security that gives the owner the right of ownership to a part of the property of a joint stock company and the right to participate in the management of this company. The owner of the share does not participate in the process of daily work of the joint-stock company, but receives profit in the form of dividends, the amount of which is proportional to the share of participation in the company. There are 2 main groups of shares – ordinary shares and preferred shares.
Ordinary shares give their holder the right to own a shareholding in a joint-stock company and the right to vote on corporate matters, such as the election of a board of directors or the adoption of corporate policies. The holders of ordinary shares are also entitled to receive general dividends. In the event of bankruptcy of the company, the owners of ordinary shares are the last to receive compensation. First of all, the companies repay their liabilities to creditors, then make payments to owners of preferred shares, and only then – to owners of ordinary shares. Ordinary shares may be divided into classes, such as Class A and Class B, with different voting and dividend rights for different classes of shares.
Preference shares provide their holders with additional rights and benefits over ordinary shares, such as additional rights in the management of the joint-stock company, priority dividend payments, priority redemption of shares, etc.
In the past, shareholders have been issued paper certificates that certify their right to hold a certain number of shares in a certain company. At present, the right of ownership of shares is fixed by brokers electronically. The use of modern technologies has made it possible to significantly simplify and reduce the cost of trading in shares, as there is no longer a need to physically transfer paper certificates to a broker in order to carry out trading operations.
The introduction of electronic methods of work with shares has made this trading tool available to the public. Anyone with a start-up capital of 50-100 thousand rubles can open a trading account with a broker and start trading shares. Despite the wide choice of other speculative instruments, stocks are the most preferable trading instrument for both beginners and professional investors, as they are the MARKET instrument, i.e. trading operations on stocks are carried out on stock exchanges, the activities of which are standardized and regulated by supervisory authorities. Thus, the trader’s funds are guaranteed to be protected from various types of fraudulent operations taking place in over-the-counter markets.
Professional trading in stocks is a rather complicated event, as it requires from the trader a versatile and thorough preparation. Equity price movements are more predictable than other trading instruments, but the analysis process itself takes a lot of effort and energy, as the trader must evaluate the stock not only from the point of view of technical analysis, but also to conduct a thorough fundamental analysis. Besides, trading in shares implies the use of the so-called portfolio, i.e. a certain set of shares for a trader, which allows to significantly reduce risks due to diversification of investments. Thus, a trader should analyze a considerable number of shares from the point of view of fundamental and technical analysis, and then choose the most suitable portfolio for himself.
Nevertheless, labor and monetary costs of professional training will certainly bear fruit, because the share price, unlike the prices of other trading instruments (for example, currency pairs), is formed by a sufficiently clear algorithm by a finite number of participants, i.e. a correctly conducted analysis allows to guess with high accuracy the direction and strength of the trend present on the market. In the currency market, even a thorough analysis often leads to erroneous forecasts and, consequently, to losses of the trader.
The key advantage of shares over other trading instruments is the leverage. If leverage on over-the-counter trading instruments reaches 1:1000, leverage on the stock market does not exceed 1:10. It would seem that a large leverage is a plus, but just the opposite. The possibility of using large leverage pushes the trader to excessive use of borrowed funds. In this situation, 1 unprofitable trade can almost completely destroy the trader’s capital. Excessive risks will sooner or later lead to a margin-call with subsequent forced closing of positions by the broker. Trading in shares is less risky, which is especially important for beginners. Restrictions on the use of credit funds will allow the trader to sit through a series of loss-making transactions, stay in the stock market and, having gained professionalism, to win back all losses and earn profit.
Learn more about using leverage in this article “Leverage shoulder: Stick to two ends.”
Another important advantage of stocks over over over over-the-counter instruments is the availability of all the information needed to conduct meaningful trading operations, in particular trading volumes. Forex trading volume, for example, is indirect and does not reflect the real situation. The volume of trading in the stock market is a specific and accurate value corresponding to the actual state of affairs. Volume information is very important for making informed trade decisions and is used in various trade strategies.
The main minus of the shares is the minimum amount of investments for speculative trading operations. More or less decent income covering commissions can be obtained by investing 50-100 thousand rubles. However, it is possible to earn on the price movements of shares with more modest capital – with the help of CFD.
By definition, CFD (Contract for difference), or “contract for difference” is an agreement between two parties to transfer the difference in value of an asset between the current moment and the end of the contract. In other words, the CFD seller gives or receives the difference between the current value of the underlying asset and its value at a future point in time from the buyer. For example, suppose the current value of Microsoft shares is $100. Seller and buyer sign a CFD on Microsoft shares. If the value of the shares increases, for example, up to $110, the buyer of the contract can fix the profit, and he will earn 10 dollars from 1 contract. On the other hand, if Microsoft’s shares fall to, say, $90 and the buyer decides to close the position, he will suffer a loss of $10 per contract. In the first case, the profit is received by the buyer, and in the second case – by the seller.
When operating CFDs, there is no actual purchase/sale of a security, only the difference between current and future stock quotes is taken into account. In this regard, the purchaser of CFD does not become the actual owner of shares and, accordingly, is deprived of all privileges of the shareholder – the right to receive dividends, the right to vote, the right to compensation for the value of shares in the event of bankruptcy of the joint-stock company.
The key difference between CFDs and stocks is that they are an over-the-counter CFD. Thus, there are no obligations and guarantees from brokers on CFD contracts, as this instrument is not standardized and regulated by supervisory authorities. On the other hand, the trader avoids expensive administrative and other costs associated with the acquisition of shares. In this regard, the trader does not need to use a large initial capital, because the commission on CFDs are very low and easily pay off if you get at least a minimum profit.
Very often analogies are made between CFD trading and Forex trading. Many brokers even allow you to trade currency pairs and CFDs from a single trading account. Indeed, the principle of trading organization and the rules of trading in these instruments are very similar, but the basic asset of CFDs are still shares, and the price movements of shares can be predicted, in contrast to the price movements of currency pairs. Therefore, if you choose between the currency market and CFD, I prefer the latter.
If you choose between stocks and CFDs, if the trader has sufficient capital (from 50-100 thousand rubles), I recommend you to start trading on the stock market. The stock market has strict regulatory requirements, which will make your profit or loss depend solely on your decisions and actions, and not on unfair manipulations by intermediaries. In any case, stock trading requires a long educational process (usually self-educational), so before you start trading, carefully assess all possible risks and aim for a long struggle in the financial field. Sooner or later, success will definitely come.
(For a full list of proven brokers for CFD trading, please go to the CFD Brokers section.)