We have moved away from traditional trading. Several instruments and securities at our dispense and the development in technology have positively altered how traders, investors, and brokers interact in the market. Even if you prefer to trade stock market indices, the way it can be done now is very different from what it used to be two decades ago. If you wish to invest in the stock market, you must gain some exposure to a stock index. This is a cost-effective and easy way that offers instant diversification.
You can receive more benefits from trading indices instead of individual stocks as indices introduce you to the entire industry. Trading individual stocks are more demanding because you must read individual companies’ reports and then compare them to identify the trends. This is a complicated and time-consuming process that can be eliminated when you focus on the industry at large. Another major benefit of trading indices is that you don’t have to worry about one company’s underperformance as the outperformance of some other company can negate it. It would help if you focused on the average of the industry here. This point also makes indices less volatile than individual stocks and makes index trading comparatively safer.
Not everyone is comfortable directly investing in an index, especially new traders. If you belong to this lot, you can consider an indirect investment. This can be done in the form of CFDs and ETFs. Let’s explore the two alternatives individually to conclude which one is better.
Index ETFs
ETF stands for Exchange Traded Funds. These are similar to mutual funds that can be traded on an exchange similar to common stocks. Index ETFs are hailed as ideal trading instruments since their creation. These stand for the indirect ownership of assets like stocks, bonds, currencies, and other commodities. Assets that are similar in nature are paired together in Index ETFs. For example, energy stocks and agricultural instruments. Traders are supposed to choose ETFs that are sector-specific and then invest. In comparison to mutual funds, you get lower fees and higher daily liquidity. This is why more investors are drawn towards ETFs.
Index ETFs do not give ownership of the asset to the investors. They are supposed to speculate on the movement related to the said index. Index ETFs are more suitable for investors looking to make short-term profits, though it involves a higher degree of risk than long-term ETF investments.
Index ETFs offer diversity, which is appreciated by today’s investors. You get high liquidity at a relatively low fee as these are traded on a public stock exchange. The list of benefits doesn’t end here. You also get capital gains tax exemption because of their public disposition, reasonable liquidity, and special dividend treatment. If you are an ETF trader, you can expect a lower commission from brokers.
If you have sufficient capital and don’t need high leverage, investing in an ETF will be the best option for you. You will get the opportunity to utilize your capital without taking a huge risk completely. Their components balance eTFs because when the value of one instrument goes down, the other’s appreciate.
Dollar-cost averaging, asset allocation, betting on seasonal trends, hedging, swing trading, sector rotation, and short-selling are some ETF trading strategies that offer several features. Beginners and novice traders will find this useful.
Index CFDs
While the ETFs have been around for a while, the CFDs are newer derivative financial instruments. CFDs, contracts for difference, are derivatives products that allow traders to trade on live market prices without owning the trading instrument. The investor is asked to pay 5-10% of the underlying asset when they open a position. A CFD contract does not expire. You can renew it after each trading day if you feel that the position is benefitting you.
Investors prefer CFDs as these instruments minimize the risk factor by spreading the investment across an entire segment instead of concentrating it on a particular company. As your investment is diversified, most of the factors that could impact your investment are taken care of. You will get both market and instant execution options with CFDs. You will get fast and easy trading as your orders are executed on time. It would help if you speculated on the direction in which the prices of assets will move. Based on these speculations, the investor signs the contract to exchange the gap in the assets’ initial and final prices. Speculation can be made of both falling and rising markets. Since the CFD collection is one of the biggest registered stocks on a stock exchange, you get global market access, higher leverage, lower transaction cost, and non-stop trading.
CFD vs ETF
The major difference between CFD and ETF are:
- While both Index ETFs and Index CFDs were introduced in the 1990s, the former has been around for a longer period of time.
- An investor must pay the full amount of the underlying asset as leverages are not common in ETFs, but in Index CFDs, you are supposed to pay 5-10% of the asset.
- Since there is no leverage in ETFs, your account can never go negative as you can only lose the amount you have invested. Such is not the case with CFDs. You can lose more and get into a debt-trap if you are unable to manage the leverage.
- You will not be charged any interest on the ETFs as long as you hold them. As CFDs are margined products, you must pay interest for the period you hold them.
- You can make both short-term and long-term investments using ETFs, but these are generally used by investors who are hoping for steady smaller gains stretched over a period of time. CFDs are mainly used for short-term gains.
- Since your broker will offer leverage on CFDs, you can make higher profits on CFDs than ETFs. However, ETFs involve limited risk as compared to the CFDs.
Before you choose one of the above instruments, you must educate yourself about the underlying assets. Index ETF and Index CFD are both popular and come with their set of cons and pros. Your expectation from your investment will tell you about the one that is more appropriate for you.
