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On LinkedIn I saw an ad claiming I could buy some AAPL stock for as little as $50. I clicked and came to a site called eToro that calls themselves a "Social Trading Network". It appears the buying of Apple stock for just $50 is using something called a "CFD".

  • What is a "CFD"?

  • Is eToro legitimate? I tried looking for information beyond their site but am not sure what I can trust. Much of the information about the company seems related to foreign exchange.

  • Is buying $50 worth of Apple with a "CFD" just like investing in the stock itself or are there special risks?

  • Is there a better way to buy a small amount of an expensive stock like Apple?

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Do you know what CFD means ? You don't. Don't try dealing in, what you don't understand in the financial markets. My suggestion is DON'T DO IT. Today 50, tomorrow 1000 and so on. Something to read on CFD en.wikipedia.org/wiki/Contract_for_difference –  DumbCoder Dec 6 '12 at 16:29
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DC - sorry you didn't make this an answer, it's a +1. "Don't buy what you don't understand" This rule of thumb will always be valid. –  JoeTaxpayer Dec 6 '12 at 17:58
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@JoeTaxpayer A good rule of thumb, but the question also seeks to understand, so that isn't actually a complete answer. I'd have converted it to a comment, were it an answer. –  Chris W. Rea Dec 6 '12 at 18:26
    
@DumbCoder surely if a person doesn't know what a CFD is a reasonable course of action would be to seek further knowledge by say asking a question on money.se? –  thepassiveinvestor Dec 31 '12 at 11:10
    
@thepassiveinvestor - I didn't get your point. I believe the question has been answered succinctly below by Waldfee –  DumbCoder Dec 31 '12 at 15:18
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5 Answers

Concerning the Broker:
eToro is authorized and registered in Cyprus by the Cyprus Securities Exchange Commission (CySEC). Although they are regulated by Cyprus law, many malicious online brokers have opened shop there because they seem to get along with the law while they rip off customers. Maybe this has changed in the last two years, personally i did not follow the developments.

eToro USA is regulated by the Commodity Futures Trading Commission (CFTC) and thus doing business in a good regulated environment. Of course the CFTC cannot see into the future, so some black sheep are getting fined and even their license revoked every now and then. It has no NFA Actions: http://www.nfa.futures.org/basicnet/Details.aspx?entityid=45NH%2b2Upfr0%3d

Concerning the trade instrument:
Please read the article that DumbCoder posted carefully and in full because it contains information you absolutely have to have if you are to do anything with Contract for difference (CFD). Basically, a CFD is an over the counter product (OTC) which means it is traded between two parties directly and not going through an exchange.

Yes, there is additional risk compared to the stock itself, mainly: To trade a CFD, you sign a contract with your broker, which in almost all cases allows the broker

  • to re-quote you,
  • quote you any price they want,
  • they do not even have to buy it back from you in most cases,
  • they often do not execute your orders timely

A CFD is just a derivative financial instrument which allows speculating / investing in an asset without trading the actual asset itself. CFDs do not have to mirror the underlying asset's price and price movement and can basically have any price because the broker quotes you independently of the underlying.

If you do not know how all this works and what the instrument / vehicle actually is and how it works; and do not know what to look for in a broker, please do not trade it. Do yourself a favor and get educated, inform yourself, because otherwise your money will be gone fast. Marketing campaigns such as this are targeted at people who do not have the knowledge required and thus lose a significant portion (most of the time all) of their deposits.

Answer to the actual question:
No, there is no better way. You can by the stock itself, or a derivative based on it. This means CFDs, options or futures. All of them require additional knowledge because they work differently than the stock.

TL;DR:
DumbCoder is absolutely right, do not do it if you do not know what it is about.

EDIT:
Revisiting this answer and reading the other answers, i realize this sounds like derivatives are bad in general. This is absolutely not the case, and i did not intend it to sound this way. I merely wanted to emphasize the point that without sufficient knowledge, trading such products is a great risk and in most cases, should be avoided.

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Are CFD's legal in the US? According to the Wiki article - they're not. –  littleadv Dec 6 '12 at 19:37
    
@littleadv: Yes, they are prohibited in the US, just like Spot Foreign Exchange (FOREX). Most online brokers who are not based in the US are not accepting US clients anymore because of those regulations. It seems, though, that it is possible to trade such products with a foreign entity, but I am not very familiar with US law and cannot give detailed insight on this subject –  Waldfee Dec 6 '12 at 19:44
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I think that's the simplistic answer, not the simple answer. I know of a service/broker in Canada called Canadian ShareOwner Investments where one can purchase fractional shares in many large companies. It isn't a derivative, but a fractional interest in a real share held in street name, by the broker. There might be similar services for small investors in the U.S. or elsewhere. ShareBuilder? –  Chris W. Rea Dec 6 '12 at 22:49
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@ChrisW.Rea I never heard of fractional shares, sorry for getting that wrong. Thanks for getting me up to speed on the topic. –  Waldfee Dec 6 '12 at 22:54
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@Waldfee FOREX is not prohibited in the US. and the only futures contracts that are prohibited in the USA are "onion futures" and "box office receipts", so what are you talking about? –  CQM Dec 7 '12 at 2:31
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As many people here have pointed out, a CFD is a contract for difference. When you invest in stock at eToro, you buy a CFD reflecting a bid on the price movement of the underlying stock, however, you do not actually own the stock or hold any rights shareholders have. The counterparty to the CFD is eToro. When you close your position, eToro shall pay you the amount representing the difference between your buy and sell price for each stock.

I suggest you read the following article about CFDs, it explains everything clearly and thoroughly: http://www.investopedia.com/articles/stocks/09/trade-a-cfd.asp#axzz2G9ZsmX3A

As some of the responders have pointed out, and as is mentioned in the article, a broker can potentially misquote the prices of underlying assets in order to manipulate CFDs to their advantage. However, eToro is a highly reputable broker, with over 2 million active accounts, and we guarantee accurate stock quotes. Furthermore, eToro is regulated in Europe (Germany, UK, France, etc.) by institutions that exact strict regulations on the CFD trading sector, and we are obligated to comply with these regulations, which include accurate price quoting.

And of course, CFD trading at eToro has tremendous benefits. Unlike a direct stock investment, eToro allows you to invest as much or as little as you like in your favorite stocks, even if the amount is less than the relevant stock price (i.e. fraction stocks). For example: if you invest $10 in Microsoft, and on the day of execution eToro’s average aggregated price was $30 after a spread of 0.1%, you will then have a CFD representing 0.33 stocks of Microsoft in your eToro account.

In addition, with eToro you can invest in stock in the context of a social trading network, meaning that you can utilize the stock trading expertise of other trader to your advantage by following them, learning their strategies, and even copying their stock investments automatically. To put it briefly, you won’t be facing the stock market alone!

Before you make a decision, I suggest that you try stock trading with an eToro demo account. A free demo account grants you access to all our instruments at real market rates, as well as access to our social network where you can view and participate in trader discussions about trading stocks with eToro, all without risking your hard earned money. Bottom line – it’s free, there are no strings attached, and you can get a much firmer idea of what trading stocks with eToro is like.

If you have any further questions, please don’t hesitate to contact us through our site: www.etoro.com.

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There are some useful answers here, but I don't think any of them are quite sufficient. Yes, there are some risks involved in CFD trading, but I will try and give you information so you can make your own decision.

Firstly, Cyprus is part of the EU, which gives it a level of credibility. I'm not saying it's the safest or most well regulated market in the world, but that in itself would not particularly scare me away. The far more important issue here is the risk of using CFDs and of eToro themselves.

A Contract for Difference is really just a specialization of an Equity Swap. It is in no way like owning a real stock. When you purchase shares of a company you own a real Asset and are usually entitled to dividends and voting rights. With a CFD, what you own is one side of a Swap contract. You have a legal agreement between yourself and eToro to "swap" the return earned on the underlying stock for whatever fees eToro decide to charge. As already mentioned, CFDs are not available to US citizens.

Equity swaps have many benefits in financial markets. They can allow access to restricted markets by entering into swaps with banks that have the necessary licenses to trade in places like China. Many "synthetic" ETFs use them in Europe as a way to minimize tracking error as the return is guaranteed by the swap counterparty (for a charge).

They also come with one signficant risk: counterparty credit risk. When trading with eToro, for as long as your position is open, you are at risk of eToro going bankrupt. If eToro failed, you do not actually own any stocks, you only own swap contracts which are going to be worthless if eToro ceased to exist.

CFDs also have an ongoing cost to maintain the open position. This makes them less suitable for buy and hold strategies as those ongoing costs will eat into your returns. It's also not clear whether you would receive any dividends paid by the stock, which make up a significant proportion of returns for buy and hold investors. eToro's website is fairly non-committal:

eToro intends to offer a financial compensation representing the dividends which will be allocated on stocks, to the extent such dividends shall be available to eToro.

All of these points expose what CFDs are really for - speculating on the stock market, or as I like to call it: gambling. If you want to invest in stocks for the long term, CFDs are a bad idea - they have high ongoing costs and the counterparty risk becomes significant. Wait until you have enough money and then buy the real thing. Alternatively, consider mutual funds which will allow you to purchase partial shares and will ensure your investment is better diversified across a large number of stocks. If however, you want to gamble and only keep your position open for a short time, these issues may not be of concern to you.

There's nothing wrong with gambling, it can be fun, many people gamble in casinos or on football matches - but bear in mind that's what CFDs are for. CFDs were in fact originally created for the UK market as a way to avoid paying capital gains tax when making short term speculative trades. However, if you are going to gamble, make sure you're not putting any more than 1% of your net worth at risk (0.1% may be a better target).

There are a few other ways to take a position on stocks using less money than the share price:

  • Fractional Shares may be available, depending on your broker. Although, these are more commonly awarded as part of dividends paid in stock
  • Derivatives, CFDs (swaps) are one example, but exposure can also be gained using Options and Futures (which have their own risks to consider)
  • Leverage, either using a derivative or by borrowing money from your broker. Highly dangerous to the inexperienced investor as it's possible to lose (a lot) more than your initial investment.

Fortunately, eToro do not allow leveraged purchase of stocks so you're reasonably safe on this point. They claim this is because of their 'responsible trading policy', although I find that somewhat questionable coming from a broker that offers 400:1 leverage on FX pairs.

One final word on eToro's "social trading" feature. A few years ago I was in a casino playing Blackjack. I know nothing about Blackjack, but through sheer luck of the draw I managed to treble my money in a very small amount of time. Seeing this, a person behind me started "following" me by putting his chips down on my seat. Needless to say, I lost everything, but amazingly the person behind me got quite annoyed and started criticizing my strategy. The idea of following other people's trades just because they've been lucky in the past sounds entirely foolish to me. Remember the warning on every mutual fund:

Past performance does not guarantee future returns

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As Waldfee says, CFDs are a derivative (of the underlying stock in this case). If you are from the USA then they are prohibited in the USA as has also been mentioned. They are not prohibited, however, in many other countries including Australia.

We can buy or short sell (on a limited number of securities) CFDs on Australian securities, USA securities and securities from many other countries, on FX, and different commodities. The reason you are paying much less than the actial stock price is worth is because you are buying on margin. When you go long you pay interest on overnight positions, and when you go short you recieve interest on overnight positions (that is if you hold the position open overnight).

Most CFDs are over the counter, however in Australia (don't know about other countries) we also have exchange traded CFDs called ASX CFDs. I have tried both ASX CFDs and over the counter CFDs and prefer the over the counter CFDs because the broker provides a market which closely but not exactly follows the underlying prices. Wlth the exchange traded CFDs there was low liquidity due to being quite new so there was the potential to be gapped quite considerably. This might improve as the market grows.

All in all, once you understand how they work and what is involved in trading them, they are much easier than options or futers. However, if you are going to trade anything first get yourself educated, have a trading plan and risk management strategy, and paper trade before putting real money on the table. And remember, if you are in the USA, you are actually prohibited from trading CFDs.

Regarding the price of AAPL at $50, the price should be the same as that of the underlying stock, it is just that your initial outlay will be less than buying the stock directly because you are buying on margin. Your initial outlay may be as little as 5% or lower, depending on the underlying stock.

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It's not necessarily true that you are paying on margin. eToro doesn't actually offer margining on CFDs. It's perfectly possible to enter a swap for 0.1 shares of Apple, which is quite different to buying 1 share with leverage. –  thepassiveinvestor Dec 31 '12 at 12:19
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"Is eToro legitimate?"

If you have any doubts about eToro or other CFD providers (or even Forex providers, which are kind of similar), just type eToro scam in Google and see the results.

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Would you offer some commentary or interpretation of the search results you suggest? I see a good amount of conflicting information, dubious websites claiming both sides of the issue. I don't care about eToro personally, but this answer is pretty short. –  MrChrister Jul 4 '13 at 23:52
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