One of the most common bases on which traders can invest is shares (stocks). Shares, which are effectively units of ownership in incorporated companies, sit as the keystone of the whole financial trading industry, and perform a crucial role in both commerce and trading. From cash trading through to derivatives like CFDs, shares are at the forefront of our collective attention as a market, and play a critical role in the function of global economies. But how do shares and CFDs intersect in practice, and what are the advantages of trading shares through CFDs as opposed to directly, or through other derivative instruments?

Why Do Traders Buy Shares?

Shares are bought because they represent corporate ownership. One share is one unit of ownership in the relevant underlying company, and entitles the bearer to a unitary share of company profits, along with a unitary share in corporate decision making through voting rights, with both weighted proportionately to fairly reflect percentage ownership. Shares have an inherent value, to the extent that the business has a positive balance sheet, in that they represent at least a unitary entitlement to the liquidated value of the business. This allows traders to speculate, and forecast on the basis of over and under-pricing as to whether a share is likely to rise or fall in future. Furthermore, as a particularly responsive instrument to business and economic performance, share positions can be researched and reasoned to reduce the risk involved in a particular trade. For example, if a company released strong financial data, its perceived value will increase assuming there is general market optimism on the strength of the result. Because this cause and effect link can be established between intra and supra market events and share pricing, they represent an ideal investment proposition for traders looking to deliver a return.

How Are Shares Invested In?

Direct trading in shares is relatively straightforward. Shares can be held by any natural or legal person – i.e. any human or business with a legal personality distinct from its owners – and the trade in shares is relatively seamlessly conducted through brokers providing access to the markets directly. Shares are priced with a notional value and an added premium to represent future value and other criteria that factor in to price determination, such that a notional one pound share might actually be priced at 247p on Tuesday and 229p the following Friday. This notional share value is used as a constant to denote the shares proportional value on a per unit basis, while the premium denotes the basis on which price speculation can take place. So, while 10 shares will remain a fairly constant percentage of ownership (unless more shares are issued, or the company buys back equity), the market price of those 10 shares will vary on a constant basis to reflect supply and demand, amongst other things, as driven by market, political and economic prompts. Shares are usually just invested in directly by traders, paying cash for equivalent shares, although they are also traded heavily through derivatives such as futures, options and, of course, CFDs.

Why Are CFDs Traded On Shares

Share trading is arguably the foundation on which all financial trading is based. But in recent years especially, share trading directly has proportionately dwindled in comparison to the growth in derivative forms of trading on shares – most notable contracts for difference. There are a number of key reasons why this set of circumstances has come to pass. Firstly, CFDs bring in the advantage of leveraged trading so traders can effectively make more money pound for pound on the exact same trades as if they were trading in the markets directly. So, a winning trade that would once have been worth 0.1% might now be worth 2%, simply through switching the instrument through which the shares are traded. This is of course a major advantage for most traders, who are out in the market to make as much as possible from their price speculating activity. But CFDs also bring with them tax advantages (being as they are exempt from Stamp Duty), cost efficiencies in terms of broker fees, and extensive flexibility to go long or short with equal ease, helping to round out the picture of why CFDs are considered a viable (and increasingly popular) alternative means of trading in shares than doing so directly.

CFDs vs Shares

So how do CFD trading and share dealing actually compare? CFDs bring a number of advantages over direct investment, but none more prominent than more significant returns. The bonus of leverage makes it possible to derive more efficient, more substantial returns on your money over a much shorter time period. This is tempered, however, by the increased risk profile of trading through CFDs as compared to trading in shares directly. As inherently valuable assets in their own right, shares are definitely more secure investments than CFDs, because they have some residual value independent of their market price. CFDs on the other hand are highly risky because they are transparent, personal contracts to pay the difference between opening and closing prices on highly leveraged transactions. As such, a loss on a CFD share position can be many multiple times greater than the same loss in a pound-for-pound cash trade.

On a similar vein, shares are assets in their standalone form, that can be bought, sold or put to practical use through voting in strategic company decisions at general meetings. While this makes them more desirable for investors looking to play a more active role in the management of their companies than speculators, it does attract additional tax liability in the form of Stamp Duty, which is an added pressure on the profits of the speculator that is relieved through trading CFDs. While CFDs represent the more tax efficient option, they offer absolutely no control or inherent value, and as such are definitely more suitable for speculators than those looking to seize control.

While CFDs deliver a number of crucial benefits for share traders over direct transactions, that doesn’t render shares an unviable or unattractive investment proposition. Determining whether to use CFDs to trade shares should be a case of weighing up the particular circumstances, and deciding whether a slow and steady long-term approach is more or less suited than a shorter-term, higher risk (but higher reward) opportunity.