When you start investing in CFDs, the most used derivative for trading online, you need to understand which asset is best to do it: the choice is wide, the main types of assets that CFDs offer are currencies, stocks and stock market indices, commodities. The right choice is to invest in the asset that you know best, the one in which you have the most experience.
In this guide to CFDs (contract for difference) I list the main types of assets to invest in with all the advantages and disadvantages, but first let’s try to understand what CFDs are. Enjoy the reading.
What are CFDs
CFD means contract for difference, a contract made on the difference in value of the underlying, accrued between the time of signing the contract and its maturity. In other words, a CFD is a contract between trader and broker, which expresses the difference in price of a market asset.
The difference is between the purchase and closing price, multiplied by the number of stocks specified in the contract. It is a way of operating that closely follows what happens in the purchase of stocks. The prices indicated by the CFD broker are very similar to the market price and it is possible to trade CFDs by receiving a commission charge.
Investing Long and Short with CFDs
CFDs reflect the value of the reference asset. The trader’s gain is the difference between the value when opening the position and when closing it. So with CFDs traders can take long or short positions, since the gain (or loss) is in the difference of the market price. Trading with CFDs earns from both the rise and fall of currencies, stocks, commodities, indices and cryptocurrencies (if the “bet” is successful, of course).
Contracts for Difference are subject to leverage, which allows you to increase earnings proportionally to leverage. So a leverage set at 1:30 will allow an investment of € 1,000 to become € 30,000. Earnings will be related to this amount, therefore they will be much greater.
You have to be careful because the same goes for losses and if they exceed the invested capital it would be at risk. But usually an automatic stop loss is expected.
Invest in currency CFDs
The currency market, or forex, is certainly the most used in CFD trading. You invest in a specific currency pair, for example the currency pair EUR/USD or EUR/GBP. In addition to these two known currency pairs, all currency crosses can be invested with CFDs.
Advantages and disadvantages of investing in CFDs on currencies
The advantage of trading currency CFDs is the abundance of currencies to choose from and the relative simplicity of this asset. Surely the ease with which it is possible to get to the news that influence currencies is one of the great advantages of this investment, because even small investors can have all the information and make accurate forecasts.
The disadvantage of investing in currencies is that it is a highly volatile market, influenced by many economic and non-economic news, for this reason it can sometimes be difficult to predict with certainty the trend of the currencies in which you invest, especially when there are important fundamentals news.
Invest in CFDs on commodities
Commodities are a particular type of investment that allows you to have different options than those offered by other assets and which guarantees, in any case, a good profit. The most common raw materials are gold, silver, or energy products, such as oil.
Investing in commodity CFDs can be an interesting alternative to currency CFDs and allows you to enter a sector that, at times, could be more stable than that of currencies.
Advantages and disadvantages of investing in commodity CFDs
Commodities offer good protection against inflation and economic uncertainty. Gold, for example, is considered the ultimate safe haven in times of crisis. When the economy is falling, governments must print money to stimulate the economy, which increases inflation and makes money less valuable. The more money is printed and the higher the inflation, therefore investing in raw materials can protect against this risk.
In addition, commodities are always part of a well diversified investment portfolio.
The main disadvantage is that, depending on the asset chosen, there could be a high volatility to be taken into account, which could lead to losing money if not managed well.
On the other hand, there are also commodities linked to the performance of the economy: for example, the price of oil collapsed in April 2020 mainly due to the lockdown for the containment of the coronavirus pandemic. In cases like this, the weaker the economy (or the stronger the shock) and the lower the demand for this raw material, which leads to a drop in its price.
Invest in stock CFDs
Stocks are perhaps one of the most common investments used in CFD trading, but also one of the most complex assets. The stocks on which to invest are many, such as those of technology companies (including Google and Microsoft, for example), or bank shares.
Investing in CFDs on commodities, advantages and disadvantages
The advantage of this type of investment is that you can have really many opportunities available, which allows you to choose the one that you think can be best for you (the one you know or can follow more easily).
The disadvantage is certainly that of necessarily having to stay updated on the stock market, which certainly is not easy when it comes to companies. The risk is that of losing particularly important news and, for this reason, making the wrong investments.
Invest in market index CFDs
Investing on stock market indices are an interesting alternative to buying stocks or trading individual stocks. The indices on which it is possible to invest are obviously those of the most famous stock exchanges in the world, such as those of the London, Paris or New York stock exchange. The value of a market index is calculated on the performance of the main shares of a specific exchange. The average of the movements is used to determine whether the index value, on a trading day, has gone up or not.
Just like with stocks, it is not easy to trade CFDs with stock indices, since you must always be informed about the indices themselves and the movement of the reference market. However, for some investors it is a sector in which it is slightly easier to find information, since it is necessary to take a look at the actions and the economic situation of a country together, rather than to the individual actions and the individual companies.
As with stock market shares, the best thing to invest in indices with CFDs is to be an expert in this market already. Otherwise it is better to opt for other types of assets, such as currencies or commodities.
There is no better investment than others, it all depends on the experience of the investor: if for example you have already tried to invest on stock market, trying with CFDs could be easier than completely changing the sector.
For beginners who have never invested and who are approaching the world of investment for the first time with CFDs, surely the best assets to invest in are currencies and commodities.