CFDs have become quite popular in recent years, especially for those investors looking into diversifying their profile and maybe already investing in stocks CFD may be something they are interested in exploring.
Among the many assets that traders can invest in, stocks or forex are probably the favourite ones, but CFDs offer some interesting opportunities to reduce risk and explore other areas in which to make a profit.
We will define what CFDs are and how do they work, as well as deepen in the differences with stocks in hopes of helping traders decide what assets may be best suited for them
What are CFDs?
CFD stands for contract for difference. This means that when talking about CFDs we refer to a contract agreed upon by seller and buyer in which the latter has to pay the difference in the value of an asset at a particular time compared to the contract time.
When investing in CFDs, traders are stipulating and hoping to profit from the price movements, without the need of owning the asset.
This is a very interesting point because traders do not need to invest and own the stocks, for example (though CFDs on other assets is possible too). Instead, they can invest in the change of value regardless of the value of the asset itself. Clearly, an advantage to those traders who may find assets to be out of their budget, they don’t need to buy those very expensive stocks, but they can profit from them through CFDs.
How do CFDs work?
When we talk about a contract, we normally refer to the broker, as the seller, and the investor, as the buyer. They will exchange the result of the difference in the value of a certain asset comparing the time of opening and closing of the contract.
Entering the world of CFDs is something that mostly attracts experienced investors since there are some perks that need to be understood in order to make a real profit from this.
As we have mentioned, investors never own the underlying asset. They can stipulate and bet on an increase or decrease of the value of Apple stocks, without having to invest and buy such stocks.
It’s important to note that CFDs are not allowed everywhere. In the UK it’s possible to trade CFDs, however in America is a different story.
When we are talking about CFDs there are some tools that investors can use, for example, leverage, in order to maximize their earnings. Some brokers may also offer features that will help traders control the risk that comes from this type of trading, which is something investors should look into before fully diving into the world of CFDs.
Stocks or CFDs?
We have already established that one of the main differences is that while with stocks, investors own a little piece of a company they are interested in, CFDs do not involve buying an asset. As it can be inferred, this means that investors can buy CFDs without having to invest a large capital.
CFDs allow for the use of leverage, an interesting feature that if used wisely will help investors guarantee higher earnings even with a rather small initial capital. However, leverage is a tool better reserved for experienced traders as with anything that maximizes your chances of higher revenue, it also multiplies the risk involved.
In the same way, with CFDs is not rare that the losses exceed the initial investment, and traders must be aware of this possible outcome. When we are talking about stocks, the losses will never go over the costs of stocks at the time of buying them.
Choosing stocks over CFDs may be a better option for newer investors or those taking their first steps in the world of online trading.