For a long time, the investment options available to businessmen have always been forex and stocks. With a rise in technology, a lot more people are also investing in contracts-for-difference, or CFDs. These financial instruments are known for the great availability of leverage. Many people who want to make huge margins of profits are instantly attracted to this market because of the leverage. But is great leverage the only thing you should consider when choosing CFDs over stocks, for instance? We will look at the difference between CFDs and stocks to ascertain what each investment option entails.
The fundamental differences between CFDs and stocks
In order to understand the key differences between CFD vs stock, the key issue to consider is the commodity of trade. For stocks, an investor buys into a small portion of a company and gains from any profits that that particular company makes. These gains are earned in the form of dividends. Stocks are sold at the stock market at prices that are determined by demand and supply forces. Most investors make money from selling the stocks they own in a company after they have appreciated over time.
CFDs, on the other hand, are not like stocks. You do not buy into an actual share in an asset. Instead, you simply sign a contract with a provider to earn a profit by exchanging a difference in value from the price of a particular commodity. In essence, you don’t get to own any assets but you receive the difference in price as detailed in the contract you sign.
In the stocks market, the value of the assets you buy is exactly the same as what you pay to get them. An investment of $1000 dollars will thus attract shares worth that amount. For CFDs though, there is leverage provided by the CFD provider. If the value of CFDs is placed at $1000 for instance, the provider might require you to pay only 5% of that value in order to sign the contract. This means that the value of your gains will also be higher because of the leverage margin. The loss margins are also big as well if the CFDs do not earn returns at the market. There is, of course, a fair share of other factors to be considered when investing in CFDs. The big leverage margin though is the main factor that attracts CFD investors.
Every form of trading has a number of risks associated with it. Most people might be familiar with the risks associated with the stocks market because there are media reports made frequently about this market. In the stocks market, the level of losses can equal the amount of investment when the market situation is bad. For CFDs though, the level of losses could be many times bigger than the initial investment. Since the CFD market has a huge amount of leverage, it is possible for investors to incur exponential losses. Investment loss is not the only risk associated with the CFD market though. There are other kinds of risks in the market, including execution risk, gapping risks, and counterparty risks. Getting acquainted with the market is vital if you want to avoid all the risks.
Nature of trade
In the stocks market, you can trade in any market around the world. This is also the case with CFD markets. When it comes to time though, the stocks market is a long-term market while the CFD market is a short-term market. Investors in the stock market often have to wait for long periods for their shares to appreciate but CFD investors can make as many investments as they wish in the short term period. When it comes to regulation, the stock market is known to be heavily regulated. There are many parties involved in this market and regulation is necessary to keep the market safe. The CFD market is however not as regulated. It is up to the CFD investor therefore to manage their risks.
To conclude, there are many things to consider when you want to invest. Issues like expertise are crucial whether you are involved in the stock or CFD market. A lot of management issues are also involved in either trade. The key differences are nevertheless highlighted in the above points. Choosing the market carefully will be crucial for your success.
Categories: Stock Market
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