The world of investing offers a variety of ways to put your money to work. CFDs (Contracts for difference) and traditional share trading are two popular options.
CFDs allow you to speculate on the price movements of various assets without direct ownership, while share trading involves buying and owning actual company shares.
While CFDs are still picking up the pace due to regulations and volatility, share trading, on the other hand, is a more established strategy.
Studies show about 61% of adults in the United States invested in the share market in 2023. And as more companies are listed, this number is likely to go up.
Each method carries its own set of benefits and risks. Understanding their key differences is crucial for making informed decisions that align with your investment goals and risk tolerance.
Whether you want to try out CFDs or share trading, this guide will help you decide on the right option. Read on for more details.
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Share trading means directly investing in shares of publicly listed companies. So, you’re basically buying company shares.
This means you own a small portion of that business and have a vested interest in its performance.
It’s one of the most popular investment markets, and more people are getting into it, thanks to the abundance of valuable resources on how to invest in shares, and the stability and growth potential it offers over other markets.
Trading in the stock market has several benefits, such as the following:
- True ownership stake – Owning shares means you have certain rights and privileges in a company, such as voting on key decisions and possibly earning dividends.
- Generally less risky – While share prices fluctuate, share trading is less risky than speculative leveraged CFD positions, particularly for long-term buy-and-hold investors.
- Growth potential – Historical stock market trends show reliable long-run upward trajectories. So, investing in fundamentally strong companies can yield appreciating value over years and decades. Patience and reasoned selection are key.
The less volatility and more predictability of share trading make it more desirable for risk-averse investors.
While share trading has numerous advantages, it’s important to understand the disadvantages, too. They include the following:
- Requires more capital upfront – You must fully pay for the purchase price when buying shares. No leverage means more cash is needed.
- Narrower asset selection – Share trading mostly focuses on stocks and ETFs tied to equity markets rather than other underlying securities.
- Difficulty profiting from price drops – While possible through short selling, reliably benefiting from falling share prices tends to be more complicated than simply buying stocks.
With these disadvantages, you can compare how they measure with the advantages before deciding if it’s the right option.
What Are CFDs And How Do They Work?
CFDs fall under the category of derivative trading instruments. This means their valuation derives entirely from the price activity of underlying security rather than having inherent value themselves.
The security could be a stock, commodity, index, or other tradable asset.
Advantages Of CFD Trading
The speculative nature of the CFD market makes it attractive to many traders, thanks to its several advantages. These include the following:
- Powerful leverage – One major attraction of CFDs is the ability to trade on margin. You only have to put down a small deposit percentage of the total position value. Trading leveraged products significantly amplify potential gains, allowing you to realize higher returns with less upfront capital.
- Access to diverse markets – CFDs grant exposure opportunities beyond just stocks. You can trade CFDs on indices, commodities, forex currency pairs, cryptocurrencies, etc. This provides greater diversity when implementing trading strategies across various underlying assets.
- Go long or short – CFDs allow you to speculate on rising and falling asset prices. Opening ‘short’ positions means you stand to profit when the market value of the security declines. This flexibility lets you target opportunities in upward and downward price trend directions.
Despite these benefits, several other disadvantages may discourage traders, as discussed in the following section.
Disadvantages Of CFD Trading
The speculative nature of the CFD market comes with so many downsides. Some of the major ones include the following:
- Higher risk profile – While leverage presents chances for amplified returns, it also introduces higher risks, given how losses can multiply rapidly in volatile markets. For example, a 2022 survey in the UK showed that over 80% of traders incurred losses in CFD trading. As such, controlling risk is crucial for CFDs.
- No asset ownership – Because you never own the underlying security, CFD trades don’t provide benefits associated with ownership, such as corporate voting rights or dividend eligibility.
- Overnight financing fees – Allowing CFD positions to remain open beyond the standard daily market trading session typically incurs small incremental financing fees. These recurring charges can accumulate over time.
So, before diving deep into CFD trading, make sure to take these pitfalls into account.
Final Words
When weighing CFD trading versus share investing, properly aligning the choice with your financial situation, objectives, and temperament is vital.
CFDs offer opportunities for rapid gains yet carry a greater risk of losses. Share trading revolves around long-run growth through company ownership.
Evaluating your risk tolerance and strategy goals is crucial for deciding which path to emphasize. Consulting an advisor can also help construct a balanced approach tailored to your needs.
