Investing and CFD Trading: How Are They Different?
By Space Coast Daily // July 7, 2021
If you are at the beginning of your journey on financial markets, the terms investing and CFD trading are everywhere. Understanding the peculiarities of each process will help you pick the right strategy for you, depending on your skills and preferences. To find out the difference between investing and online CFDs trading, please continue reading.
What is CFD trading?
CFDs, or contracts for differences, are the type of financial instruments that make it possible for traders to benefit from the movement of prices (either going up or down) on a certain market. They represent a type of agreement between two parties to exchange the difference between the initial and exit prices on an asset, which can be securities, commodities, cryptocurrencies, and more.
The main thing to remember about CFD is that you don’t become the owner of a chosen share. What happens is that you have a contract with a certain broker, and trading will be carried out according to an open position.
What about investing?
When it comes to investing, the goal of this method is to deposit money at a certain moment and then receive profit in the future. There is nothing immediate about this process. For instance, you can purchase stocks of a certain company, and they will be worth more over time if a company continues to develop and become more successful. It is important to have enough knowledge to be able to assess the long-term potential of the chosen company.
How are CFD trading and investing different?
Investing and CFD trading are two different approaches. The most important difference between them is the fact that CFD trading doesn’t lead to purchasing an underlying asset. When it comes to investing, you do own a certain financial product as a result of purchasing it on the market.
Another significant thing is that investing is considered mostly a passive activity while CFD trading is active. For instance, CFD traders may hold their positions open for no more than a day. This won’t work in investing, as the purchased assets are held by investors for several months or years. They expect to get long-term returns. Some traders use CFDs for long-term trading, but this is not as common.
What should also be mentioned is that CFDs are not subject to stamp duty, as you don’t buy assets. At the same time, the capital gain tax still applies if you make a profit.
Advantages of CFDs
When it comes to CFDs, there are several advantages associated with them and something you won’t be able to get with investing. This includes an opportunity to go short, a range of markets, and leverage.
Being able to go short
A big reason why many people are attracted to CFDs is the fact that you can both sell (go short) and buy (go long). When it comes to selling, you can make a profit in the case that the prices for a certain asset fall. You can make your prediction in either direction when you trade, which is a definite advantage of CFDs.
On the other hand, when we take shares investing, you almost never go short, as the process becomes highly complicated. To go short, it’s necessary to borrow stock in hopes of reselling them. For this reason, it’s not surprising that investors are focused on going long and wait for the prices to rise over the course of months or years.
Another thing that should be mentioned as the advantage of CFDs is the fact that you can use leverage. It means that you get access to all the different financial market instruments and achieve exposure while making only a certain deposit.
For example, all you need in some cases is to make a 5% margin deposit in order to perform a transaction. It means that by investing only 5% of the total value of your position, you still have an opportunity to earn 100% of losses or gains.
On the contrary, when you decide to invest in shares, you don’t have the benefit of leverage. You have to pay the full price if you want to earn anything in the future.
Does leverage have disadvantages?
When you are a beginner, it’s important to keep in mind that leverage can also lead to more losses. The reason is that when the broker lends you the capital, there is an interest charge applied if you leave it open overnight. This type of charge is referred to as a swap fee.
If you physically buy a product, the equity loss can be less significant, so it’s something to consider. And, you won’t have to deal with the charge that is applicable in the case of CFDs. As a result, you can hold onto your shares for longer and without the risk of huge losses due to fees.
Another thing that should be mentioned when it comes to CFDs is that you don’t get additional rights when trading stock in this way. When you are a shareholder, you may be able to vote on certain decisions in the company and thus affect its future. Only physically owning the company’s shares grants you important rights.
A range of markets
Getting access to a wide selection of financial products is also something you get with CFD trading. It is possible to choose from commodities, shares, equity indices, cryptocurrencies, Forex, and more. When we talk about the most common financial products that can be traded using contracts for differences, they include stock indices, metals, and stocks. Oil and precious metals, such as gold and silver, have always been popular, but these days more and more traders are also getting into tech stocks. This is only logical, as the industry continues to grow every year.
Another huge market involves cryptocurrencies. The majority of CFD brokers offer this type of trading, and it is possible to engage in cryptocurrency trading even without creating special wallets.
When it comes to investors, their focus is on asset and share investing, which can be quite limiting for some people.
Are CFDs suitable for long-term investment?
If you are someone interested in long-term investment, CFD trading is probably not the best decision. The majority of traders do not view CFDs as a long-term investment opportunity. There is a high level of volatility associated with CFDs, which means that holding a position for a long time can result in high fees. This is a short-term instrument, and it’s perfect for that purpose. For this reason, it is better to consider stocks if your focus is on long-term investment.
Two different yet effective approaches
Both investing and CFD trading are effective ways to make a profit on financial markets. There are a few crucial differences between them, so it’s important to choose what you like the most based on your plans, capital, experience, and more. CFD trading is definitely a more suitable option for beginners because of leverage and other benefits. But, if you are interested in long-term investment, it is not used for this purpose.
What are your thoughts on CFD trading and investing? Do you prefer one over another? Feel free to tell us what you think in the comments below!