With so many new ways of investing and trading being introduced in recent years, it’s no wonder that people are constantly asking which is the best choice for them. The answer to this depends on what you want from your trading experience – it’s usually a balance between financial returns and risk, and you need to become an informed investor/trader to see which trading instrument works best for you.
Exchange traded funds, or ETFs as they are commonly known, have been much vaunted as the ideal investment and trading vehicle since their inception. In their simplest form, they are just like other funds such as mutual funds with the exception that they are traded on an exchange, hence the name. This means they can vary in price during the day, just like shares, and can be used by a trader to squeeze out a profit on a short-term basis. However, as funds they are also suitable for longer-term investment, and can be based on many different underlying goods, such as stock indices, commodities, bonds, currencies, etc.
While frequently you may buy, or go long, in an exchange traded fund, they can also be used for short positions. For instance you can find ETFs that behave inversely to indices, going up in value when the index goes down. ETFs are also available in a form that multiplies the difference, going up twice as much as an index goes up for example. This makes them very flexible for many people.
Contracts for difference, or CFDs, on the other hand have been around for even fewer years than exchange traded funds, but are also available to be traded on many different underlying markets. CFDs allow you to contract to receive or pay the difference in price over time of the underlying financial instruments, taken from when you open your trade to when you liquidate your contract. You benefit to the extent a stockholder or owner would from an increase in price, but without buying the underlying goods.
But when you come to compare CFDs with ETFs, you will find that there are many differences. CFDs are a derivative, giving you substantial gearing of your investment, which means you can control and profit from the change in price of a much higher value of security than you could buy with the same money. Typically you will only have to pay 5% to 10% of the value of the underlying. While some ETF’s can manipulate the paybacks, they are not leveraged as such, and you need to pay the full price for them.
The other difference, arising from this, is that CFDs are subject to interest charges for the period that you hold them. Because they are a margined product, you are also open to the broker requesting more money from you, a margin call, if the value falls. He has to do this to protect his interests from you defaulting on the debt. If you have an active interest in trading, and intend to take profitable positions, then the leverage of CFDs far outweighs these disadvantages when compared to ETF’s.