Highlights 

Contracts for difference (CFDs) and exchange traded funds (ETFs) are fundamentally different instruments. While CFDs belong to the class of financial derivatives and do not involve trading the underlying asset, ETFs are baskets of assets traded on centralised exchanges. 

Despite this key distinction, there are some similarities between the two: for example, while CFDs allow you to use leverage directly, ETF traders can magnify their positions via leveraged ETFs. 

What are other key differences and similarities in trading the two? 

Read on for our guide on CFDs vs ETFs.

CFDs vs ETFs

A CFD is a contract between a broker and a trader to exchange the difference in value of an underlying security between the beginning and end of the contract, often less than a day. With CFDs you can open a long position to speculate on the asset’s price to rise, and you can open a short position. 

When trading CFDs, it’s important to remember that you do not own the underlying asset, you’re only getting exposure to the price movements. With CFD trading, you’re always offered two prices based on the value of the underlying instrument. These are the buy or ask price, and sell bid price.

Trading CFDs also allows you to use leverage, which can magnify both profits and losses. For example, if you want to open a position worth $1,000 and your broker offers 1:10 leverage (or 10% margin) for the instrument you want to trade, you’d only need $100 as the initial capital. The rest will be borrowed to you by your broker. 

An ETF is a basket of securities, which allows traders to gain exposure to a broad range of assets and speculate on price fluctuations.

ETFs are among the most popular financial instruments that investors add to their portfolios for exposure and diversification. Instead of having to research or analyse individual instruments, they allow you to track the performance of a group of assets or a stock index. 

Different types of ETFs

There are various types of exchange-traded funds, based on their asset class, geography, industry selection, and other themes.

CFD vs ETFs: Five key similarities 

The key similarity between CFDs and ETFs is the versatility of the markets and asset classes they cover. From stocks, indices, forex, commodities, and many more, both instruments provide traders with a wide range of options. 

• Both CFDs and ETFs allow trading a variety of underlying markets: ETFs can be made of stocks, currencies, commodities, indices, and other asset classes. CFDs too can be derived from the prices of stocks, currencies, commodities, indices, and more.

• Leverage: CFDs allow you to trade on margin and use leverage. With ETFs using leverage is less straightforward, yet there is an option of a leveraged fund. Note that leverage can magnify your profits as well as your losses.

• Speculating in both directions:  With CFDs you can go both short and long, which allows speculating on both rising and falling prices. With ETFs you generally go long, yet there is an option of Inverse/Short ETFs, which rises in value if its benchmark drops in value. 

• Hedging: A trader can use ETFs and CFDs to hedge other positions in their portfolio.

• Spreads: Both CFDs and ETFs incur a spread – the difference between the bid and ask price. 

CFDs vs ETFs: Five key differences

There are, however, multiple ETF vs CFD differences. The key distinction is the different types of instruments they are. A CFD is a derivative and is only based on the underlying asset, which can also be an ETF. Meanwhile, owning ETFs means owning the assets within the funds. 

• Type of instrument: The key difference between CFDs and ETFs is that CFD is a financial derivative that can use any security – including an ETF – as its underlying asset, while an ETF is a fund composed of other securities such as stocks, forex, and more. 

• Ownership of the underlying asset: ETFs involve owning the assets within the fund’s components. Meanwhile, with CFDs traders speculate on the asset’s price direction, without owning it. 

• Overnight fees: When a trader wants to keep their CFDs position open overnight, they would typically be charged an overnight fee. This makes CFD trading short-term in nature. ETF trading, on the other hand, may be used by long-term investors. 

• Diversification: ETFs allow for more diversification and give you exposure to a variety of assets and niche markets. CFDs only allow diversification when trading ETF and index-based CFDs. 

• Regulation: ETFs are regulated to the rules of a centralised exchange. Meanwhile, a CFD belongs to the over the counter (OTC) market, this means the broker benefits from more flexible operating rules when trading CFDs.

CFD vs ETFs: What instrument to choose?

When choosing between ETF and CFD trading, traders should be aware of their risk tolerance, trading goals and the knowledge of the markets. ETFs are typically preferred by long-only longer term traders, while CFDs tend to be more short-term in nature due to overnight fees.

As a trader, you must ensure you keep abreast of changes in the market, review and improve your trading strategy and conduct thorough research before making any decisions. 

Why trade CFDs?

• Leverage: Leverage allows you to borrow money from a broker, which can give you more access, or exposure, to a market. This can lead to making greater profits but can also result in heavier losses, so be careful. 

• Go long and short: Speculate on both rising and falling prices via short and long CFD positions. 

• Regulation: CFD belongs to the over the counter (OTC) market, this means the broker benefits from more flexible operating rules when trading CFDs.

Why trade ETFs?

• Ownership of the underlying asset: If owning the underlying asset is important to you then ETFs will allow you to own the assets within the fund’s components.

• Diversification: ETFs allow for more diversification, as it gives you more exposure to a variety of assets in one fund. 

• Keep positions open for longer: If you want to stay in a position for a longer period you may choose ETFs as they involve less costs – such as overnight fees – depending on a broker.

Conclusion

Whether or not CFD or ETF trading is more appropriate for you depends on the type of a trader you are.

If you want to trade the price movements and are not concerned with owning the underlying asset, CFDs may be a more suitable option. ETF trading may be more appropriate for longer-term positions, whereas CFD trading can be effective for short-term speculation and is not encouraged for long-term positions due to overnight fees. 

It’s important to do your own research and remember that your decision on what to trade and your preferred trading strategy should depend on your attitude to risk, expertise in the market, the spread of your portfolio and how comfortable you feel about losing money. You should never trade more than you can afford to lose.