With over 190% of online interest growth in 2020, CFD (Contract for Difference) trading seems to become a competitive financial instrument. Investous.com analytics report that stock and online CFDs trading both have leading numbers of search queries amongst US users. But what financial instrument is better for your trading portfolio in 2021? This detailed pros and cons comparison will help you make the right decision.
How CFD Trading Works
Contracts for Difference are financial instruments that allow you to speculate on both positive and negative asset price trends and make profits by making the right bet. You can open short, overnight positions, or even multiple positions during the day. Opening one, you have to make a bet on whether the price of an underlying asset will rise or fall. If your prediction appears to be right by the time the contract closes, you receive the difference as profit on your trading account. If your prediction fails, you have to pay the difference out of your own pocket.
Here are the basic steps of CFD trading:
- Find a reliable broker and opening a trading account;
- Select the most familiar market;
- Find positions you are confident about and make bets;
- Close the positions to capture the result and withdraw profits or pay the difference.
Advantages of CFDs
CFDs accept various types of underlying assets, including shares (stocks), commodities, foreign exchange, indexes, treasuries, and sectors. Yes, you can make income on the price movements of all these assets. However, the largest benefit of this instrument is that it lets you start trading without purchasing any assets.
You still need money to set up an account and have the funds needed to pay debts if you lose, but the size of first-day investments is much lower than in the stock market, where you have to invest as much money as the stocks of each company cost.
In simple words, you can select the market that you understand the best and start speculating on price movements using your well-established knowledge base on particular markets.
The roundup of CFD benefits:
- CFDs allow different types of underlying assets, such as shares (stocks), commodities, foreign exchange, indexes, treasuries, and sectors;
- You can multiply your gains with leverage;
- You don’t need classic investment capital to start trading. The entry costs are the lowest on the market;
- You can open and close multiple positions within a trading day;
- You can avoid paying overnight fees;
- No need to own any assets.
Disadvantages of CFDs
Appealing advantages always have a dark side, regardless of the financial instrument you choose for your portfolio. Trading CFDs involves the following disadvantages and risks:
- You always have to pay the spread – the spread fee in CFDs is the difference between the buy and sell prices quoted for an instrument in the position. The spread decreases your initial position immediately.
- Leverage – leverage works as a profit and loss multiplier, so it can be a very positive and an extremely negative option for you. You can multiply both your profits and losses, so it’s recommended to be very modest with leveraging your positions to avoid missing all your money in just a single move.
How Stock (Share) Trading Works
Shares are public documents that let you own an actual part of a company if you buy them. Unlike CFD trading, share trading requires real asset ownership. You actually have to purchase one or multiple shares to be able to speculate on their price movement.
Once you purchase a share, you can do whatever you want with it. It’s your property and you are not pushed into any timeline to sell it. This is a great benefit as you can wait as long as you want to catch the best buy and sell price difference. Successful companies can sometimes multiply the price of their stocks in less than a year, which makes it possible to sell stocks only when they finally get more expensive.
Of course, stock prices always fluctuate up and down, so you have to learn to assess short and long-term trends to see the right time to buy and sell particular stocks. The path of each company is different, so you must be very careful to avoid losing your money.
Still, risk assessment in stock trading is as difficult as in CFD trading, but you generally have much more time to think, so you can consider it as an opportunity to avoid impulsiveness.
Share Trading Advantages
The advantages of choosing shares as your main trading instrument include:
- Opportunity to grow with the economy – successful companies grow with the economy, so do the prices of their stocks.
- Good way to outrun inflation – the average annualized return of stocks is 10%, which is higher than average annual inflation rates. It means that inflation can hardly kill the price of a stock that has an upward general vector.
- Easy to purchase and sell stocks – there are more convenient options to purchase stocks than CFDs, which makes them more accessible. You can also sell your stocks any time you want.
- Dividends for holding stocks – quite a lot of companies offer dividends to their shareholders, which lets you earn money not only on selling stocks when they grow but also while holding them.
Share Trading Disadvantages
Stocks are classic and high demanded instruments, but they have downsides too:
- Risks – companies can go bankrupt and sometimes you can’t predict it. CFDs also involve high risks, but they all come from short-term market fluctuations rather than from long-term trends.
- Time – stock trading offers multiple options for spreading your strategies in time, but short-term trading isn’t likely to bring you the same high profits as CFD trading.
- Price – stocks are much more expensive than CFDs with stocks as underlying assets.
Time to Choose
Now that you see the full picture, you can decide whether you want to embark on a speedy CFD path with low initial investments, or you want to launch a heavy stock battleship with thousands of initial investments. Both can be good for you!