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CFD vs. Investing
CFD vs. Investing

Difference Between CFD Trading and Investing

If you are a beginner trader, you can be confused when hearing that a stock can be bought (investment) and traded (CFD). What is the difference between CFD and investing? What should you choose to succeed? In this tutorial, we will compare investing and CFD trading, so you can choose what suits you more. 

CFD Trading: Meaning and Application

Let's start with a CFD term. CFD stands for a contract for difference; it is a derivative product that allows for trading the asset's price movements without ownership of the asset. The CFD price is the price of the security you trade. 

If you are familiar with Forex trading, CFD trading is the same - traders open positions based on their price predictions and either succeed if the forecast works or bear losses if the projection is wrong. CFD trading is available for a wide range of financial securities, such as stocks, commodities, indices, futures, etc. 

How the CFD Market Works

The idea of CFD is that you can trade security without owning it. For instance, if you buy commodity CFD of oil, you don't own barrels of crude oil - you can only potentially profit or lose funds from price speculation. So, you forecast a price direction based on fundamental and technical analysis and place a buy/sell order. 

You buy or go long when you believe the asset's price will move upwards. You sell or go short if you are sure the asset will depreciate and its price will decline. 

With trading CFDs, it's worth knowing such vital terms as leverage, margin, spread, and swap.

  • Leverage. When investing, you need significant funds to purchase stocks, for instance. But trading a stock CFD, you can start with $100 as CFD is a leveraged instrument. Just to remind you, leverage is a ratio of a sum you have to open a trade and a sum you use when opening a trade. Leverage raises the funds you can use to open a position. For instance, if the leverage is 1:100, you have $10,000 to open a trade vs. $100 of your own funds. 
  • Margin. Another term you should be aware of is the margin. Margin is an initial investment used to open a position. 

You should remember about risks that are applied to Forex trading as well. Leverage and margin trading raises not only a potential profit but a size of potential losses. 

As with any similar financial endeavor, CFD trading includes expenses. Here are some terms that explain expenses you bear when trading CFDs. 

  • Swap. Trading CFDs, you don't have to close a trade within a day, keeping it open as long as your funds allow you. Still, you may have to pay an amount for holding a position open. It's a swap. However, the swap isn't always a sum you pay. It can be a sum you get for holding a trade overnight. 
  • Spread is a commission you pay to a broker for executing your trade. Spread equals the difference between the ask and bid prices. 

A great feature of CFD trading is that it’s tax-free.

The CFD trading is done via brokers. You can open a position either on a MetaTrader or broker's own trading platform. The platform used for Forex trading is available for CFD trades. 

Stock CFD Trading: Example

Although CFDs are available for various assets, we would like to focus on stock CFDs as shares are widely used both for trading and investing. 

There are two options to trade the share CFD: stocks and indices.

Company’s shares. The first one is to trade stocks of a particular company. You choose what stocks offer a higher chance of moving in a certain direction and open a buy or sell trade (remember that trading CFDs, you don't own real assets, you earn on price movements, so you can both buy and sell depending on market conditions). 

A choice of stocks depends on many factors. You should apply fundamental analysis that includes financial results, internal company news, industry news, etc. Also, remember about the technical analysis, which includes indicators, chart and candlestick patterns, price volatility, etc.

NVIDIA
NVIDIA

Indices. The second option is indices. An index is a benchmark that reflects the performance of a price of several largest shares listed on a certain exchange. Here, you get a chance to lower the risks as the index is a less volatile financial product. Its direction depends on the price of all the equities included. Thus, even if one stock skyrockets, the rise will be limited by the price movements of other shares. 

S&P500
S&P500

When trading, there is no big difference between indices and real shares. You might profit from both if you know how to predict a price direction. 

Benefits and Limitations of CFD Trading 

To understand a financial product better, it's worth considering its benefits and limitations. 

Pros

Cons

Limited funding. When you trade a CFD, you can have limited funds and use leverage. 

Don't own the asset you trade. If you wish to be a shareholder, CFDs aren't for you as you just trade a price difference. 

Buy and sell. A great feature of CFD trading is that you can both buy and sell CFD. Thus, your chances double. 

Higher risks. As CFD trading reminds Forex one, high trading risks apply to CFDs too. Trading is a speculation on price movements. Markets, especially the equity one, are subject to high volatility. 

Suitable for diversification. CFDs can be used to diversify your portfolio. 

 

Rapid rewards. Trading CFD, you can open short-term trades on minute timeframes. 

 

Investing: What It Is and How to Invest

Alternatively to CFD trading, you can invest. Investing is a financial action of putting money into a financial product, in most cases acquiring it. There are many assets you can invest in. They are stocks, bonds, mutual funds, ETFs, etc. The idea is to generate income from holding the security or sell it later when the price increases. 

How to Invest

As a wide range of securities is available for investing, it's impossible to highlight common rules. Let's consider some examples. 

A deposit on a bank account is a way to invest. You put your funds on an account and get monthly income as a percent of your deposit. If you want to invest in bonds, you put your funds in them (at the time of placement or on the secondary market via a broker) and get dividends for lending your funds to a company that issued the bonds.

In the next part, we will consider ways of investing in stocks. 

Investing in Shares: Examples

There is also more than one option to invest in stocks. 

Real shares

The first way is a purchase of real shares. You buy one or several stocks of a company and get dividends for it. You can purchase stocks either through a stockbroker or directly from the company (if available). This option is available for you if you own enough money to afford stocks at their real price. Real shares can be used to diversify your portfolio. However, it can be expensive as real stocks have high prices. 

Mutual funds and ETFs

Another way to invest in stocks is to purchase parts of different shares by investing in a mutual fund. ETFs and index funds are like mutual funds; they track an index. You can combine several funds to diversify your portfolio. 

Investing: Advantages and Disadvantages 

To compare CFD and investing, we should know the advantages and disadvantages of both terms. 

Pros

Cons

Passive income. If you don't have time to stay in front of a monitor, investing is an option for you. A usual period of investing is counted in years. 

Lots of money. To invest, you need to have a lot of money. Leverage isn't available for investing. 

Lower risks. Investing includes lower risks compared to CFD trading. The price volatility doesn't play a significant role when you invest for a long period. 

Taxes. There is no opportunity to earn money without expenses. You will have to pay taxes on profit and stamp duty on each deal. 

Own an asset. You buy an asset and own it until it expires (for instance, bonds) or decide to sell it (for instance, stocks). 

Hard to diversify. Although you can diversify your portfolio with investments, it can be more expensive than using CFDs. 

Trading CFD vs. Investing in Shares

To make it clearer, look at the table below that compares trading and investing. Although you can invest and trade many financial securities, we will compare stock CFD trading and stock investing. We will highlight similarities as well as differences. 

 

CFD trading

Investing

Leverage

Available. You can have only $100 to start trading. 

Not available. The required sum depends on the price of the product you invest in. 

Timeframe

Any timeframe. You can trade CFDs even at a minute timeframe. 

Long term. Although it's possible to invest for several days, mostly investing is a longer-term activity used by passive investors. 

Platforms

Platforms for Forex brokers, MetaTrader, mobile apps.

Web-based platform, mobile apps.

Own physical shares

No. If you choose CFD trading, you only speculate on price movements. 

Yes. When investing, you buy real shares. 

Fees

Yes. You have to pay a spread (a broker commission) to open a trade and a swap if you hold a position overnight. 

Yes. You have to pay taxes on profit and stamp duty on each deal. 

Overnight cost

Yes. If you hold a position overnight, there are odds you will pay a swap. Still, swap is not always an amount you pay; you can also receive it. 

No. You don't have to pay the overnight cost. 

Dividends

No. As you don't own stocks, you can't get dividend payments. 

Yes. Investors buy stocks to get dividends though you should be careful not all companies pay dividends. 

Markets available

Over 15,000 markets which include commodities, indices, stocks, forex, etc. 

Over 15,000 shares and ETFs.

Trading/dealing hours

CFD trading is similar to Forex trading. 24-hour weekday trading on forex and major stock indices is available, together with weekend trading on selected markets.

Investors mostly buy shares of companies listed on the New York Stock Exchange (NYSE) and the Nasdaq Stock Market (NASDAQ), which are open from 9:30 am to 4:00 pm Eastern time on weekdays (closed on stock market holidays).

Cost to open positions

As you can use leverage, the cost of the position can be limited by $100 and even less. 

You have to pay the full amount of the share or fund. 

Does hedging make sense?

Yes. You can use CFD trades to hedge your investments.

Yes. Still, stocks are not the most effective way to hedge.

CFD vs. Investing: What Should You Choose?

There is no clear answer. You should choose the activity that matches your goals. In case you have significant funds and you are a passive investor, you can invest. If you are an active trader that aims for immediate rewards, although riskier, CFD trading might be a great option. Another feature of CFD trading is that you have more opportunities to open trades as it's available for buying and selling. 

If you don't have experience in either CFD or Forex trading, you should open a Libertex demo account. It resembles the real one but allows you to trade without losses and gain experience. Please remember that it's not a real account, so no loss equals no earnings. 

Why to trade with Libertex?

  • access to a demo account free of charge
  • technical assistance to the operator 5 days a week, from 8 a.m. till 8 p.m. (Central European Standard Time)
  • leverage of up to 1:600 for professional сlients
  • operate on a platform for any device: Libertex and Metatrader

FAQ 

Let's round up what we have covered. 

What Is the Difference Between CFDs and Stocks?

CFD is a contract for difference that can be used for stock trading. When trading, an investor doesn't own the equity. Stock is a financial asset that can be both traded and owned by an investor. 

Are CFDs a Good Idea?

CFDs are a good idea if you want to get rapid rewards and don't own lots of money. 

Are CFDs Dangerous?

CFDs bear risks for traders as the core idea of CFD trading is price speculations. To succeed, you need to predict the price direction correctly. It's not an easy task, but if you practice, it is possible. 

Do Day Traders Use CFD?

Yes, day traders use CFDs as it's possible to trade CFD assets even on minute timeframes. 

Is CFD Trading Easy?

Nothing is easy if you don't learn and practice. CFD trading has features you should be aware of before entering the market. It's recommended to use a demo account that allows for trading without losses (remember that it's a test account that doesn't bring real earnings). 

Is It Better to Use CFDs or Invest?

There is no best option. It would be best if you compared them and highlighted what is more important for you. If you have significant funds and want to put your money into an asset to make it work for the long term, investing is for you. However, if you are interested in potentially fast profit with limited investments, you should consider CFD trading. 

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