So which is better? Stocks or CFDs?Well, there is no one clear cut answer, but there some differences between shares and CFDs that you should be aware of to see it CFD trading is suitable for you.

As well as advantages, there are disadvantages to CFD trading that you should be also aware of, so that if you can overcome them, then CFD trading may be a profitable trading instrument.

Firstly, let’s have a look at two main reasons why CFDs are advantageous over trading stocks and shares on the stock market.

1. The use of leverage.

With CFD brokers and providers, there is 10 to 1 or 20 to 1 leverage available. This means that you can magnify your returns by 10 fold or 20 fold. The advantage of this? You can make more profits with a smaller float.

But the disadvantage of this is that if you do not have a good CFD system, or don’t know what you’re doing, then you can lose more than your float.

For example, if you buy $10 000 worth of CFDs using $1000 cash margin, and the stock CFD price goes down by a huge amount say 90% of its value and you haven’t exited, then the loss is $9000, which is way bigger than your $1000 cash margin you’ve put up for just that one trade.

So your results are bigger, so you must trade with good money management.

2. You can short more stocks when trading CFDs rather than stocks.

This means more buying and selling opportunity, so if your system is profitable over bullish as well as bearish markets, then you can take advantage of the market as it goes up or down.

Now let’s have a look at two main disadvantages of CFD trading.

One is the effect of leverage which can be good or bad thing depending on your trading system, which we talked about above. But let’s have a look at two more.

1. When dealing with a market maker type CFD provider, rather than a DMA (Direct Market Access) CFD provider or broker, then you have to deal with issues such as spread widening (if any) and slippage. Even if you use DMA CFDs, but you trade illiquid stocks then you may get slippage due to the market: that is, not enough liquidity in the underlysing stosk to get out at the expected price.

This means that if the provider executes your stops in such a way that there is a bit of a delay getting out of a CFD via your stop loss (set at say $4.75), then instead of getting out at $4.75, you may have gotten out at $4.60, which means that you would’ve have gotten out with less profit than you expected. This is called slippage.

Sometimes a marginally profitable trade can become a losing trade due to slippage.

Also, market maker CFD brokers may widen the spread more than their usual small smounts of 0.05% or whatever amount they normally have in certain times of the day, so that when you get in or out of stocks, you may get a price that is different to the one you expected.

You just have to monitor your results with your trading. This is even more so if you trade relatively illiquid stocks. You may need another source of data and ‘course of trades’ (prices and volumes) to compare.

2. There are limitations to how much you can scale your trading up depending on the market.

With CFDs in a market with high liquidity, there is less liquidity issues with the majority of CFDs.

But if you’re trying to put on large trade sizes in a CFD market that is relatively small, liquidity issues may cause it’s own slippage.

So, when trading CFDs, be aware of these pros and cons.

As with everything, there is probably no ‘perfect’ instument to trade.

But if you know what the pitfalls are, then you can overcome them to some extent by either redesigning your system or finding a different CFD provider.

Source: The CFD Trader