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How to choose the right product

Lesson 6 of 7

Find the right product

There are many ways to interact with the markets and pursue your financial freedom. In this lesson, we'll cover the different products available, their risks and benefits.

Remember, the product you choose comes down to your personal circumstances. This includes your risk appetite, when you’ll need to close your trade or sell your shares and how much time you have on hand to monitor it.

Investment products

If you’re looking for long-term returns from the market, investment products may suit your strategy. They still carry market risk, even though they’re not leveraged.

You can hold these for years on end, as long as you’re happy with the returns and quality of what you own.

Share trading

An icon of a business next to a pie chart illustrating how company shares represent different percentages of ownership.

This activity might be what you think of when the stock market first comes to mind. Share trading refers to buying ownership in listed companies directly.

If you choose to use share trading to build your wealth, you’ll be the beneficial owner of the assets you buy. It also means you’re eligible to receive dividends associated with the investment.

They’re issued at the discretion of the company, so they could choose to not proceed with them, or cease paying dividends at some point. Some companies use their profits to buy back their own shares or invest them in new acquisitions instead.

When markets are down, even the best-performing shares in the world can come under pressure and decrease in value. However, quality shares can recover over time and might reward patient investors.

Share trading enables you to build your own diverse portfolio, buying stocks in companies that you think will increase in value over time. If you decide a share isn’t doing as well as you’d hoped, you can sell it and look for a better option.

Unlike other trading products, investment accounts typically charge low or even no fees to hold your shares. That’s good news, because when you find a winning share, you might hold on to it for as long as you can. Most providers will, however, charge a commission when you buy and sell shares.

Managed portfolios

These offer an alternative to buying individual shares. They’re often managed by a broker and the legwork of selecting shares and putting together a diversified portfolio is usually done for you.

A diagram depicting how a managed portfolio may include a combination of different stocks, bonds and commodities.

Managed portfolios can be structured according to your risk profile, so you can look for one that suits you. Usually, bonds and commodities are also included in them, which can further diversify your portfolio.

Because they’re non-leveraged, you may assume that they only suit those who are more risk averse. However, managed portfolios can include riskier investments which increases the inherent liability.

These might be a solid entry point into the market as they offer both immediate diversification and expert management, all in one simple product.

Did you know?

Do you know which shares to invest in? Are you sure you have enough time to monitor them all?

By choosing a managed portfolio, a lot of the work is done for you. You can save your time and leave the diversification to the professionals. However, this isn’t a foolproof solution.

As with all portfolios, they may see price weakness in the shorter term due to overall market conditions.

Portfolio managers aren’t immune to making bad investments either – they could select the wrong sectors or shares.

Remember that you can’t invest with IG International, you can only trade using CFDs.

Exchange-traded funds (ETFs)

A diagram depicting how ETFs are made up of a combination of stocks, bonds and other assets that all follow a particular sector.

Exchange-traded funds (ETFs) track a collection of shares, such as an index, or even different assets, like stocks and bonds. They’re a relatively simple way to get exposure to a range of shares.

You buy them as you would a share in your share trading account and they may also be included in some managed portfolios.

Diverse and low-cost, they’re another path you could choose when starting your investment journey.

They’re a time saver as you won’t need to research individual shares. Instead, you can select an ETF with a theme, such as global shares. You won’t have to worry about monitoring the different shares within it.

Exchange-traded commodities (ETCs)

Exchange-traded commodities (ETCs) are similar to ETFs but, instead of shares or indices, they have commodities as the underlying asset.

It could be a single type of commodity or a diverse index of commodities around a theme, like agriculture. The latter might include a number of different agricultural products in one ETC, like barley, corn and milk.

Trading and leveraged products

Once you start taking on leverage, you’re venturing into the realm of trading rather than investing.

As you’ll have learned, shares can be bought without leverage and may be used as a long-term investment. Using leverage on the same shares would be more about their short-term price changes instead of their long-term growth potential.

Leverage helps you get greater market exposure with a relatively small initial outlay. The increased risk comes from the potential amplified profits or losses.

Many financial instruments have leverage built in and can be used on most underlying markets such as shares, commodities, forex and indices. Instead of just buying an asset outright, you’d select a leveraged position, immediately increasing the risk and the reward of the trade.

Leveraged derivatives are usually used by short-term traders who hope to profit from a market moving up or down.

Contracts for difference (CFD)

CFD trading is one way you can take a position on the price changes of an asset. Instead of owning the asset itself, you’re trading based on the price movements of that underlying market.

They also use leverage, but they’re relatively simple to understand. CFDs enable you to go long or short on any asset class.

A diagram illustrating how your profits and losses are amplified because of leverage.

The price at which you enter a CFD position is based on the value of the underlying asset. As it’s a leveraged trade, you only pay a portion of the actual cost of trading the asset to enter the market. The leverage used adds extra risk as both profits and losses can be magnified. Let’s see how this works.

Say you want to trade a particular share, which is valued at $2.45. You open a trade by buying 1000 CFDs. The total value of your position would be $2450, and you’d be required to pay a 10% margin (or $245). That gives you 10x leverage, which is ten times the exposure to the market.

Question

Using the above example, if the share price now rises to $2.60 and you exit the trade, you’ll have made a profit of $0.15 per share.

What’s your total profit and what percentage of your initial investment is it?

  • a $260 and 51.22%
  • b $150 and 51.22%
  • c $150 and 61.22%
  • d $260 and 61.22%

Correct

Incorrect

Because you bought exposure to 1000 shares, your total return is your $0.15 profit per share multiplied by 1000 which equals $150. If you divide this $150 by your initial outlay of $245 and then multiply that by 100, it equals 61.22% profit.
Reveal answer

Options

These financial instruments are slightly more complex than CFDs because of how they’re structured.

Options are contracts that give you the right, but not the obligation, to buy or sell an asset on or before an agreed date (strike date), at an agreed-upon price (strike price). You’ll pay something called a premium to buy an option, but the trade will only be executed if you exercise your option.

You’d use call options if you think that a market will rise, while put options enable you to take a position on a falling market. Because you’re not obliged to execute your trade, you can allow your option to expire if the market moves against you.

A graph showing how a call option might work when you buy the market because you think it’ll rise.

Leverage is built into the option’s price, but that’s not the only thing you’ll need to consider. Options are complex in that they have strike prices and dates. The formula for determining their value uses variables like sensitivity to volatility or the effect of changes in interest rates.

You could also use a put option as a hedging strategy if you’re concerned that markets may be falling. Rather than selling your local investments, buying a put option on an index like the US Tech 100 might help provide a layer of protection to your overall portfolio.

If the market falls, your share portfolio would be worth less, but you could make a profit on the put option, reducing your overall loss.

Want to learn more? Take our complete course on options here.

Spot trading

Spot trading is offered on forex, indices, ETFs, shares and commodities. It entails paying the current market price on whatever asset you’re trading.

A spot market can refer to both a physical underlying asset and a derivative instrument. The biggest difference is that with leveraged products, you’re not taking delivery of the underlying asset, you’re just trading on its price movements.

If you think an index will be rising in the weeks ahead, you’d be able to buy a position on it using the spot price, with added leverage that enhances the potential risk and reward of the trade.

In many ways, spot trading is trading at its most basic form, but leverage adds an element of complexity. It has no expiry, so you can remain in the trade for as long as you want without having to worry about a looming expiry.

Futures

An infographic explaining the difference between spot trading, options and futures contracts.

Futures contracts are agreements between a buyer and a seller to trade an asset at a set price on an agreed-upon date in the future. Unlike with options, there’s an obligation to complete the trade.

Further, your loss isn’t capped, and you can lose more capital than you have in your account. Say you anticipate that the price of the US Tech 100 may rise in the next three months. You take out a futures contract so that on a particular date in the future, you can buy the market at a lower price than you think it’ll be.

If the underlying market moves against you instead and the price falls, the set price you agreed to pay will now mean you make a loss. Because of the obligation to complete the trade, you’ll need to have enough money in your account to cover that losing position.

Futures also use leverage, but the cost is built into them and subtracted from the trading price every day.

You can trade them on several markets, including shares, indices, bonds and commodities.

If you’re trading on the market itself, you’ll take delivery of the asset. However, this only happens at expiry. You can avoid this if you sell the contract before then.

You can also trade CFDs to trade futures contracts, meaning you’ll never physically own the underlying asset.

Exchange-traded products (ETPs)

There’s a wide range of exchange-traded products (ETPs) available to trade, depending on where you reside. While ETCs and ETFs also fall into this category, they’re often used as part of long-term investments.

Some ETPs are more sophisticated than others and can be better suited to traders, not investors. This is because they’re designed to help you seize opportunities in the short-term moves in an underlying asset.

These products can give you exposure to a range of assets, including shares, indices, forex, commodities and even cryptocurrencies.

Choosing the right product combination

As you can see, there are lots of different products that can help you access the financial markets. We’ve covered in our previous lessons how you can use your risk profile and time horizon to help you choose which ones are right for you. However, remember that with IG International you can only trade via CFDs.

You might also consider leverage and how well you understand each product to aid in your decision making. Remember though, you can have multiple financial goals you want to achieve. Therefore, you could follow a multi-product strategy, which we’ll cover in the final lesson.

Lesson summary

  • Buying shares, using managed portfolios or investing in ETFs and ETCs fall under long-term investment activities. They don’t include any leverage and can be considered low risk
  • Short-term trading can be divided into OTCs and other ETPs. Both might be considered high risk and have their own distinct benefits
  • OTC products like CFDs enable you to trade on spot markets, options or futures
  • ETPs help you limit your risk so that you never lose more than your initial outlay
  • CFDs are considered to be leveraged derivatives, so you’ll never take delivery of the underlying asset
  • However, remember that with IG International you can only trade via CFDs

Lesson complete