ETFs and CFDs: What’s the Difference?
Trading ETFs and CFDs has become a common practice for both beginner and experienced traders. You may prefer to track the whole market at lower costs, or go in for high risk with the possibility of snatching a big win. In this article, you will learn the basic differences between the two trading methods, as well as their unique advantages and disadvantages.
ETFs Explained: What You Should Know?
Exchange traded funds (ETFs) are essentially investment funds similar to the traditional mutual funds. They are traded throughout the day on a stock exchange. This is what sets them apart from their classic counterpart, which are traded once a day – more precisely, at the end of it.
What ETFs do better than mutual funds is their relatively low cost. ETFs are considered a low-risk option because the investment is spread out over a number of different companies as opposed to an investment into a single stock. This way, you’re not having to scan the whole market and look at each company individually. Their inherent diversification and the 2650% rise of ETFs’ popularity worldwide between 2003 and 2020, demonstrates how alluring of an option it is. In fact, currently, the value of assets managed by ETFs is above 7.70 trillion USD.
CFDs: To take advantage of volatility
With contracts for difference, however, you’re not buying the underlying asset but rather speculating on the price movement of an individual asset. It’s a contract between traders and brokers. Both parties agree to exchange the difference in the price from the opening and closing points resulting in a profit or loss for the trader. Unlike ETFs, the nature of CFDs means that small movements in the market can result in magnified profits or losses within hours, minutes, even seconds.
How to Choose Between ETFs and CFDs?
Deciding whether to trade ETFs or CFDs will depend on your trading goals. If you wish to take a more passive approach to investing without getting too involved in the constant monitoring of various markets, then perhaps ETFs are more suitable for you. They are closer to traditional assets and will allow you to receive returns for your investments in an index, be it the stock market or other commodities. Trading periods tend to be in the range of shares trading. As ETFs are less risky, they are designed for long-term growth, yielding smaller gains over a longer period of time.
CFDs, on the other hand, are for individuals who have more of a risk appetite and want to take advantage of the leverage that the product offers in order to magnify their potential profits. In comparison to ETFs, CFDs are used more for short-term strategies. They also require both frequent monitoring and a deeper analysis of the underlying asset. Trading a large number of contracts will ultimately increase your risk. This is due to the possibility of undesired price movements each time a contract is active.
The Bottom Line
Choosing whether to trade in CFDs or ETFs will come down to your goals, your trading strategies and your risk appetite. ETFs usually require a larger initial investment than CFDs but involve much less risk with moderate gains. CFDs, on the other hand, are seen as high risk high reward products. Both have their advantages and disadvantages so trading one or the other will depend on your trading preferences, commitment, strategy and discipline.
Eightcap is a CFD provider and offers its traders competitive spreads and a vast library of assets to trade on. You can register for an account or try out a free demo account right away and learn more in the process as well.
Trading on margin is high risk.