Exchange Traded Funds (ETFs) and Contracts for Difference are two of the most popular trading
options today. With the trading vehicles evolving almost every day, it actually becomes difficult
for traders to zero in on a suitable option in a jiffy. The key is to understand each of these
options thoroughly before venturing into trading at the first place. ETFs and CFDs are our focus
of discussion today. And, before delving into further details of the same, let us tell you that the
selection of the ideal investment option depends a lot on your aptitude and trading objectives.
Read on to find out what exactly we mean.
What is ETF?
An ETF or Exchange Traded Fund entails the ownership of underlying assets like bonds, stocks,
oil futures, gold bars and foreign currency and the consequent division of these assets into
shares. ETFs should not really be confused with mutual funds. It is actually traded like a
common stock. If you are trading ETFs, you must do it knowing full well that they experience
price changes throughout the day as they are purchased and sold. They generally have higher
daily liquidity and lower fees than mutual fund shares as result of which they have emerged as
highly attractive options for investors.
Shareholders do not own the asset directly. They share profits in the form of the dividends or
earned interest from ETFs. They are often used by traders to eke out short term profits. On the
other hand, they are also ideal as long term investments.
What is CFD?
Contracts for Difference refer to a tradable instrument which reflects the price movement of
the underlying asset. The trader does not have to own the underlying asset. He can make
profits or losses depending on his prediction of the price movement of the asset. For instance, if
he predicts that a certain share will experience a price slump in the near future, then he can sell
off the share today. And, if his predictions do come right then, he ends up making profits even
amidst the falling price. On the other hand, if the price moves against his predictions then he
ends up making losses.
So, in a nutshell, CFD lets you make profits irrespective of rising or falling prices. Similarly, you
can make losses with price rise as well.
CFD and ETF Compared
The very first difference between ETF and CFD is that the latter has been around for a fewer
number of years than the former. If you are trading CFDs you can agree to receive or pay the
difference in price of the underlying asset between the time when you open a trade and when
you choose to liquidate a contract. They basically refer to a derivative that offer you notable
hold over the investment. You are actually in a position to make profits on a much higher value
of security than what you could actually buy with the same amount of money. ETFs on the
other hand offer you no such leverage. As a trader you have to pay the full price.
You should also be duly aware of the fact that CFDs carry substantial interest charges for the
time you are holding them. If the value of the asset falls, you may face a broker requesting
money from you. The broker does this to shield his interests from your debt default.