CFDs (Contracts for Difference) and ETFs (Exchange Traded Funds) are two quite different Financial Instruments that are sometimes confused by the new trader. In comparing CFDs vs ETFs, let’s first look at both instruments in isolation.
What is a CFD (Contract for Difference).
You’re on the right site if you are asking this question. A Contract for Difference is a leveraged contract to settle the difference in value between the starting price and ending or closed out price of an underlying asset. In nearly all cases this difference is leveraged, meaning that you are settling for a multiple of the price difference. CFDs are typically short-term plays, sometimes minutes or hours, rarely more than a few days.
What is an ETF (Exchange traded Fund).
An Exchange Traded Fund is a security that mimics the movement of an index, commodity or basket of commodities, or other asset type or class, but instead of requiring you to buy, say, all the stocks in an index such as the ASX 200 (which would require heaps of trades and the knowledge of rebalancing your portfolio constantly) you simply buy a single security, and let the managers of that security figure it out. An example of such a security on the ASX is the Vanguard Australian Shares Index ETF (ASX code VAS).
Difference between CFD and ETF
CFDs are typically more focused and nearly always much more short term speculation than ETFs. ETFs support more of the ‘buy and hold’ mentality of more passive investors; CFD traders are much more active speculators that have a specific view on the likely price change of an underlying asset. ETFs rely on the general theme and belief of most fund managers that markets tend to increase in value in the long-term; and that trying to beat an index such as the ASX200 is not necessary for long-term growth.
Which is best for me, a CFD or an ETF?
As you can see from the above comparison, CFDs and ETFs, though they may sound vaguely similar to the uninitiated investor, are markedly different in their operation, and are instruments aimed at very different use cases and ultimately types of investors, traders and speculators.
ETFs are generally considered to be significantly less risky and volatile than CFDs. CFDs are definitely aimed at the more sophisticated investor who is able to do things like analyse charts, has excellent knowledge of markets, trading platforms and is prepared to take on risk and reward. ETFs are aimed at more passive investors who want to buy and hold for the long term.
If you’re a trader who has a strong view on likely price trends and is well versed in market operation, you may consider CFDs to be a viable option for speculation. Exchange Traded Funds (ETFs) are more useful to those who are not looking for leverage and are looking for long-term results with the more common ‘buy and hold’ strategy.