The contract for difference trading (CFD) is a contract between two parties that allows one party to profit from the other party’s movement in the prices of assets. Unlike investors, CFD traders do not have an interest in the assets traded.
Which of the two products—CFD trading or investment—will give you a better return on investment (ROI)? It’s a common question among newbies in the financial sector. Both products are beneficial; all you have to do is choose the one that suits your risk appetite best.
CFD trading offers a flexible way to speculate on the value of a financial instrument. These investments allow you to trade asset price changes without actually owning the assets. CFDs are appreciated by traders who want to trade according to market trends but do not have enough capital to trade higher volumes.
This article strives to go into detail on the difference between CFD trading and investment and go in-depth on what each means to help you decide on the argument you’d like to lean towards.
CFD Trading: What is it?
CFD trading is a financial market strategy in which you trade the price movement of a security without having to own it. Using CFDs, you can speculate on whether prices will rise or fall without having to pay for the securities themselves.
Due to your indirect relationship to the asset, you stand to gain if its value increases or decreases depending on your prediction and the move of the asset in the market. However, unlike the actual owners of the asset, who only profit when its value rises, CFD trading offers you the chance to profit from both price fluctuations in both market movements.
This is what you can gain depending on the contract you sign in a given asset:
It is possible to take a “sell” position, commonly known as “going short.” This indicates that while you are interested in the asset, you believe it will depreciate in a given period of time.
Another way to trade is by means of contracts for difference (CFDs). In such cases, you open a position long and your profit is the difference between the asset’s price when you open the position and its price when you close it.
You make an actual asset purchase on investment. Unlike CFD trading, investing only reaps the rewards on the upside movement of an asset in the market. Investment requires you to only take on those assets you are confident will rise over time in value.
Consider the scenario where your friend is trying to sell their business. You want to buy the business but are unable to pay the price in full. You then request assistance from your parents and best friend. Your best friend contributes 5% of the car’s cost, your parents pay 25%, and you make a 45% payment to acquire the asset.
As a part-owner of the business, you get to make decisions about what happens in the business. The value of your share in the business goes up as more people want to buy it. When you sell your stake (or shares) in the business, you make money.
Your business shares also decrease when the business’s value decreases or the business ceases to do well. Investment works both ways.
One significant way that CFD trading and investing differ from each other is the level of control you have over the asset. CFD trading gives you the option to indirectly own a stake in an asset, as opposed to investments, which you directly own with less control of the market sentiment as an investor.
The Features and differences
You now have a basic understanding of CFD trading and investment. You are aware that one enables the purchase of the underlying asset or a part of it, and the other speculates on price movements.
In light of this, you should consider the following characteristics and variations between CFD trading and investment:
- Investing in specific circumstances comes with some advantages. For instance, if you buy shares in a company, you might be eligible to receive dividends (annual payments deducted from the company’s profit) or have a say in decisions that affect the company’s value. This way, you are part of the company.
- There is no leverage when you directly invest in a given asset. Instead, you pay the price that is displayed.
- Stocks and exchange-traded funds are available for investment (ETFs). You may also invest in different types of assets, like cryptocurrencies.
- Your exposure determines your risks and expenses, so the maximum risk you can handle is only as high as your initial investment.
- Leverage presents you with numerous opportunities for financial gain. It can increase your losses as well. To reduce these risks, it’s crucial to implement the proper risk management procedures.
- You are making value speculation regarding the asset. You may choose to use leverage, which implies that you can invest a small sum and still be exposed to the entire asset’s value.
- Let us say an asset has a value of USD 3000 for illustration purposes. So you could risk 300 USD with 10X leverage to gain full exposure rather than 3000 USD (300 X 10 = 3000).
- You can trade various financial instruments such as CFDs such as stocks, forex, indices, futures, and commodities.
- CFD trading allows you as a trader to hedge your position according to how you anticipate price movement. Unlike actual investments, where you only make money if the value of your asset increases, you can make money on market movements of either side.
Both CFD trading and Investment have their own risks. To find the best that works for you, you must know your risk appetite and level of patience when it comes to investment.