In addition to the traditional forms of investment, such as stocks, bonds, mutual funds, and real estate, Contract for Difference (CFD) trading has gained significant popularity in recent years. While both aim to profit from market movements, there are some key differences worth discussing.
Let’s take a closer look at four differences between CFD trading and traditional investing:
Ownership of Assets
The most obvious difference between CFD trading and traditional investing is the ownership of assets. Let’s look at this way: When you buy stocks, you own a piece of that company. This ownership comes with certain benefits, such as dividends and long-term returns.
With CFD trading, you’re not buying an asset, but speculating on its price movement. You enter into a contract with your broker and agree to exchange the difference based on whether the price goes up or down. CFD trading ensures flexibility, but you might miss out on the long-term benefits of owning assets.
Leverage
One of the many reasons why experienced traders are drawn towards CFD trading is the usage of leverage. It allows traders to control a much larger position with a smaller amount. Leverage is expressed in a ratio and depends on your broker. For instance, if you’re trading a CFD worth $10,000, the broker might only require you to deposit $1,000. Here, the leverage ratio is 10:1.
Traditional investment doesn’t offer such benefits. When you buy a stock or a share, you have to deposit the full amount up front.
Due to leverage, CFD trading allows you to enter numerous global markets with little initial capital. This may not be applicable for traditional investment vehicles.
Profit Potential
With traditional investment, you can earn profits through various means. Stocks bring dividends, whereas bonds provide interest payments. Almost all traditional investment vehicles follow buy-and-hold strategies, which means you only profit when the asset’s value increases over time. The market can decline due to inflation, economic reports, and political events, you have to wait for recovery.
CFD trading allows you to earn profits from both rising and falling markets by going long (buying) and short (selling). As a result, you can earn profits even during small price fluctuations.
Risk Level
All investments carry risk. That being said, traditional investment vehicles are generally considered low-risk. Since the positions are limited to the trader’s capital, you can’t lose more than what you’ve invested. But keep in mind that market downturns, inflation, or poor company performance can lead to losses.
Have you ever wondered why CFD trading is recommended for experienced traders? It is a high-risk venture mainly due to leverage. You can incur losses if the speculated price movement isn’t executed. Many brokers issue a margin call, which means you have to deposit additional funds or securities.
The good news is that you can implement numerous risk management strategies for both CFD trading and traditional investment. Use stop-loss orders and take-profit orders as well as diversify your portfolio to ensure protection against uncertain conditions.
