The Difference Between CFD and Investment Accounts
Contract for Difference (CFD) and investing stand for popular strategies of engaging in trading in financial markets. This piece of writing discusses the differences between CFD and investment accounts. Also, we tackle each approach’s unique features and benefits.
In order to explain the core difference between CFD and investment accounts, here are a few takeaways for beginners:
CFDs vs Investing in Brief
CFD trading and investing represent two ways of taking a position on an asset’s price movements. Here are the main differences:
- Investing comprises direct ownership of the asset. When you buy the asset, you will need to put the total value of the asset you are buying on your investment account.
- When it comes to CFD trading, you don’t have to be the asset owner. Be it shares, commodities, or currency pairs, trading with CFDs implies that you buy the contract from your CFD broker.
- Since the trader doesn’t buy any assets, CFDs and spread betting are free from stamp duty. CDFs don’t count as an asset. Instead, they have accounted for revenue and capital gains tax accordingly.
- The value of the CFD doesn’t rely on the value of an underlying asset. Its value comes from the difference between the entry and exit position of the trade.
- You can use the leverage if you trade CFDs. On the other hand, if you invest in shares of a company, leverage is now allowed.
- Going short is one of the significant perks of CDF, along with the availability of many financial instruments like currencies, cryptocurrencies, equity indices, commodities, shares, and more.
- Investors are more passive and constrained. They focus their attention on asset investing only by being involved in a buy-and-hold strategy.
The Difference Between CFD and Invest – CFD Meaning Explained
So, what is CFD trading? As we can see, the very meaning of CFD entails the financial contract that enables traders to profit from the changes in prices of an asset.
- CFD trading means that you open the trading account on the trading platform that allows CFDs. These trading platforms are also popular under the name of CFD brokers.
- CFD trading is especially advantageous for short-term traders. As a CFD trader, you can profit from the price movements by going short or going long, depending on whether you are buying or selling.
- Selling the asset means you are going short, expecting the price of the trading instrument will fall. And if you are buying the asset, that means going long expects the price to go up.
CFD and Leverage – Risks and Perks
The core advantage of CFD trading lies in the possibility of using leverage. It’s a tool that gives you full market exposure to the financial market of your choice.
The leverage applies only to derivative products. Their value is derived from the price of many underlying assets such as commodities, currencies, indices.
To trade these derivative products, you need to deposit the minimum required to open a CFD position. This deposit is also known as a margin deposit.
It represents the initial amount a CFD trader needs to open a leveraged position.
Basically, you fund the account with a portion of the total value of the trade. And your broker loans you the rest of the amount for greater exposure.
Let’s suppose you want to open a $100 CFD position for Amazon shares trading. You will also need to deposit $20 of a margin to trade the price movement of Amazon shares price.
The usual margin requirement for trading stock price movements goes between 5% and 20%.
Beware that trading with leverage using margin carries risks. While it can amplify profits, it also can lead to a big loss. That’s because these are calculated based on the total size of the CFD position rather than only the margin account.
In our example, profit or loss have been calculated relying on the position’s full size, which is $100 and not just a $20 margin.
The Difference Between CFD and Investments
To put into perspective the core difference between CFD and investment accounts, let’s take a closer look at what investment really is in financial markets.
- First and foremost, investment is a longer-term approach in comparison to CFD trading. Therefore, investing turns out to be a more suitable option for those having an optimistic long-term prediction on the specific share price or the exchange-traded fund – ETF.
- As a retail investor, besides benefiting from an increase in assets prices, you can even get voting rights within the company that you are a shareholder of.
- As a direct investor, your risk is equal to the total value of the shares you have bought. If you buy a share for a price of $1000, that’s also the maximum you could lose. That is even if the shares price drop to zero.
- When investing on a brokerage platform, the retail investor buys a number of the company’s shares or other assets. It then waits for the value to increase, so the investor can sell them to make a profit.
- Finally, investments can bring you profit just in case the assets price, be it shares or ETF, goes above the price of your opening investment position. And that’s also one of the main differences between CFD and investment account. CFDs allow you to benefit from the ups and downs in the market. It makes a contract for difference particularly suitable for trading currencies on Forex due to the volatility of the currency rates.
CFD vs Investing – Costs, Financial Products, Trading Terms, and Regulations
CFD contracts are especially convenient for volatile markets such as the Forex market. Today, a multitude of forex brokers offer access to hundreds of global financial markets. However, most of the platforms offer multiple assets trading. Therefore, a trader opens and closes positions on Amazon, Apple, gold, the FTSE 100, and currency pairs at their choice.
It is also possible to trade cryptocurrency CFDs since it doesn’t involve owning cryptocurrency as an asset.
On the other hand, an investment account might be a good match for you if you are happy going with global stocks and ETFs.
The Costs of CFDs
Trading costs may comprise a financial cost, commissions, and the spread. The spread means the difference between the price you buy it at and the offer price at the moment of the trade. A brokerage company’s profit comes from these spreads. The spread usually depends on the volatility of the particular asset.
Regarding Forex and commodities, generally, there is no commission. Margin requirement depends on the instrument and the amount you want to use for trading.
The Cost of an Investment Account
When investing, one can expect these trading costs: commission, spreads, and operating expenses. These costs vary according to the asset class you invest in. Some brokers enable guaranteed stops and charge a fee for this service or compensate costs in another way.
While the ETF and stocks make a large part of worldwide markets, CFDs are subject to some restrictions.
Major markets such as UK, Hong Kong, Netherlands, Germany, France, and Norway allow CFDs. The USA doesn’t enable US citizens to trade contracts for differences. However, non-US citizens can use them in trading.
Regarding Australia, ASIC’s intervention order is effective since March 2021. It will introduce some changes regarding leverage for retail investors.
Finally, before you decide to venture into any type of investment, you ought to carefully consider regulations in your country, your risk tolerance, and your experience level.
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