The way traders, investors and brokers interact in the market has also positively changed many devices, securities and technological developments. Investment and trade in recent years have brought many new ways. Also, even if you want to trade stock market indices, there are plenty of alternatives to choose from. Gaining exposure to a stock index is one of the best ways to invest in the stock market. It is easy, cost effective and provides instant diversification.
Not everyone is comfortable directly investing in an index, especially new traders. If you also belong to this lot, you can consider an indirect investment. If you are still wary of investing directly in an index, there are two ways to indirectly invest – Index ETFs and Index CFDs.
Let’s explore the two alternatives individually to conclude which one is better. What are crypto CFDs and ETFs, how do they work and why do they matter? Find the answers to these questions in this article.
CFD’s and ETF’s
The Contract for Differences (CFD) and the Exchange-Traded Fund (ETF) are two financial instruments and the most traded products on the financial markets. This is justifiable since the characteristics of the two instruments are perfectly tailored for short-term traders, as opposed to long-term investors. Long reserved for institutional investors, these products are now attracting an increasing number of retail and professional traders that are drawn to their relative simplicity.
Index ETF’s
Index ETFs represent the ownership of underlying assets, such as bonds, stocks, commodities and currencies. When it comes to index ETFs, assets with a common characteristic are usually clubbed together, such as energy stocks, agriculture instruments and so on. So, you can choose a sector-specific ETF for your investment. They normally provide higher daily liquidity and lower fees than mutual funds, which has made them an attractive option for investors.
Here, the investor does not own the underlying asset. They merely speculate on the movement of the index. Index ETFs can be used to make short term profits, although it is important to also remain aware of the associated risks. They are also great for long term investments.
The advantages of trading Index ETFs include diversification, high liquidity, relatively low fees and easy trading, since ETFs are traded on public stock exchanges. Other benefits offered by index ETFs include capital gains tax exemption, special dividend treatment and reasonable liquidity. Brokers also offer low commission rates to ETF traders.
Index ETFs are perfect for investors who are not looking for high leverage, have high capital and are looking for a trading experience to utilise the capital. The components of an ETF balance each other out. If one instrument’s value goes down, another instrument’s value might go up and even things out.
Index CFD’s
Index CFDs helps spread the risk across an entire segment rather than investing in on a single company. This diversifies the investment and takes care of most of the factors that could affect the share price of a single company. Index CFDs are available with both instant and market execution. Your orders are executed without any delay, leading to fast and efficient trading.
Trading CFDs involves speculation on the direction of movement of an index, where the investor agrees to exchange the difference in price between the start of the contract and its end date. Allowing traders to participate in the global financial markets, an Index CFD is a collection of the biggest stocks registered on a specific stock exchange. The best part is that one can speculate on both rising and falling markets.
Which could be the best one?
- Index ETFs have been around for longer than Index CFDs.
- In Index ETFs, you have to pay the full price of the underlying asset, whereas in Index CFDs, you agree to receive or pay the difference in price between the opening and closing dates of the contract.
- With Index ETFs, you can never lose more than your initial investment. However, with Index CFDs, the use of leverage means that both profits and losses will be multiplied.
- Index CFDs are usually used for short-term strategies, whereas Index ETFs are usually used to yield smaller gains over a longer period of time.
- Index CFDs have high risk and high reward potential, whereas Index ETFs are usually meant for smaller gains over a long period of time.
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. 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.
Conclusion
While concluding this article it is generally accepted that ETF trading may be better-suited for opening long-term positions, whereas many traders turn to CFD trading for more short-term operations, as they simply want to trade on the asset for a quick profit and not own the underlying security. These types of traders use short-term strategies such as scalping, day trading and swing trading. For most investors, therefore, CFDs are opportunities that are used for speculation purposes. As for ETFs, the long-term investment is the only option. Both opportunities are great options for investors who are acquainted with the markets. It is nevertheless, important to understand the risks in the market before making investments in either market.