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The Limitations of CFDs
Retail brokers are continually expanding the collection of assets offered on their trading platforms . Nearly all retail brokers now offer trading in the major asset classes, such as stocks, ETFs, commodities, indices, and forex. Many also include cryptocurrencies in their offering.
All that sounds very appealing, especially considering the strong gains in these markets since the March bottom. Maybe you have decided to simply pick a broker and start participating in these trends. After all, brokers are making it possible for you to invest in these thrilling market opportunities, right?
Not exactly. Most online brokers offer CFD trading of the assets only. Yes, you can trade the CFD instruments listed on the platforms, but it is not possible to actually invest in the underlying assets from which the CFDs are derived. That is because contracts for difference, or CFDs for short, are vehicles that enable one to only speculate on the price changes of a financial asset. But CFDs are not a gateway to investing in the underlying asset.
CFDs Are Not the Best Vehicle for Investing in Stocks
A CFD allows you to potentially profit on the change between the price at which you enter and the price at which you exit. The difference between the two prices represents your profit or loss, depending on whether you went long or short on the asset.
“What’s wrong with that?” you ask. “Isn’t buying low and selling high the whole point of investing in financial markets?”
Yes, it is, but it is only part of the story.
There are some downsides associated with long CFD positions. For example, fees tend to be much higher when buying stocks via CFD contracts than when investing in them by buying the underlying asset. Not only will you pay the spread — and a potentially large one, at that — but you will also be subject to overnight rollover rates. A rollover fee is charged for holding an open position overnight.
While these swap rates are not necessarily high, they will slowly eat into your potential profits while you hold the investment.
Furthermore, you will not receive any of the dividend payments that the companies pay to their shareholders because you are not a shareholder when trading the stock via a CFD.
But wait a minute. Are CFDs all bad, unsuitable for any market condition? Quite the opposite. There are absolutely some unique advantages that CFDs provide and situations where they are more suitable than other financial instruments. Read on, and we will come back to this later in the article.
Before that, let’s look at how you can actually invest in underlying assets if CFDs are not the best way to go.
Take Advantage of Buying Underlying Assets With eToro
First, you will need a broker that lets you invest in the underlying assets. eToro is a leading brokerage that allows investors to buy stocks , ETFs, and cryptocurrencies. When you do so, you will get the full benefits that come with buying the underlying asset. Moreover, you will pay no commission on these positions due to eToro’s zero commission policy.
No overnight, management, or ticketing fees are charged on positions in underlying assets on eToro, no matter how long you hold them. This kind of investing is particularly suitable for long-term investors. If the companies in which you have invested, pay dividends, you will receive the payments directly in your eToro balance.
Unlike with CFD positions, when you buy the underlying asset on eToro, the asset is bought and held in your name. For investors interested in tapping into the crypto space, eToro even provides a cryptocurrency wallet that can be accessed from inside the eToro trading and investment platform . You can use this wallet to store any of the supported digital coins, no matter where you bought them.
The Advantages of CFDs
As we said earlier, there are some unique advantages to a CFD derivative. Let’s dive into them.
The two main upsides of trading CFDs are leverage and the ability to short any asset. On eToro, you won’t miss out on either of those advantages because eToro offers CFD trading as well.
Leverage gives you the ability to control a larger position than the amount you have in your account. For example, some traders may find the use of leverage advantageous for trading assets that are not very volatile because it amplifies the potential gains. However, leverage also amplifies any losses incurred by the same ratio.
Leverage is not available if you want to invest in the underlying asset. In this case, you have to front 100% of the money that you intend to invest. For example, if you want to invest $5,000 in a particular stock, then you will need to have at least that much money in your account in order for the trade to be executed. If you want to use leverage for whatever reason, then you can select this option on the eToro platform, and your trade will be executed with leverage as a CFD.
The other main advantage of a CFD is that it simplifies shorting the market if you think prices will fall. The traditional way to short stocks is relatively complicated and involves borrowing from someone who owns them and then selling the stocks in the market. A contract for difference makes short selling a straightforward process. You agree to pay the difference in the price if you are wrong, and your broker will pay you if you are right.
It is important to remember that despite many advantages, investing in CFDs involves risks.
Verdict: CFDs vs Buying the Underlying Asset
Trading CFDs and investing in the underlying assets each have their own advantages. While CFDs may work fine for Forex trading, many investors want to tap into the full potential of stock investing, which is not accessible via an instrument such as CFDs. However, CFDs are more suitable for short-term speculating on price changes, regardless of whether the market is moving up or down.
The ability to potentially profit when markets are both rising and falling is an important advantage for many investors. For others, it is the ability to buy the underlying asset and hold it for a long time. Whether you choose to go with one or the other depends on your preferences and investment style. But no matter which one it is, you will find a large selection of financial instrument, both CFDs and underlying assets, on eToro.
Visit eToro.com today and find out how you can tap into the full potential of investing in underlying assets.
Disclaimer:
eToro is a multi-asset platform which offers both investing in stocks and cryptoassets, as well as trading CFDs.
Please note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 71% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.
Zero-commission is only available to clients of eToro (Europe) Ltd. and eToro (UK) Ltd., and does not apply to short or leveraged stock trades. Zero commission means that no broker fee has been charged when opening or closing the position. Other fees may apply. For additional information regarding fees click here. Your capital is at risk.
