Disclaimer: The products or services discussed in this article may not be offered by Taurex and may only be listed here for educational purposes.
Forex (foreign exchange) and CFDs (contracts for difference) are trading instruments that have become popular with many traders worldwide.
In 2020, the global CFD market was valued at an estimated $5.7 billion and may rise to $7.6 billion by 2029. Similarly, the forex trading market boasts a staggering daily turnover of around $7.5 trillion.
You may be among those intrigued by forex and CFD trading but not sure about where to begin or which option to choose.
There’s also forex CFD trading, a combination of these trading instruments.
Understanding their differences and similarities is crucial as it may give you an advantage in trading.
This article introduces forex (foreign exchange) and CFDs (contracts for difference) and their similarities and differences.
It also points out key advantages and disadvantages of CFD trading, especially for new traders.
Finally, this writeup introduces forex CFD trading, select trading strategies, and key terminologies a trader must know to ensure good decision-making in their trading journey.
CFD vs. Forex – Learn About Their Similarities and Differences
CFDs and forex trading are popular among many traders and investors today. These two trading opportunities have similarities and differences that traders must understand to make informed decisions.
Remember that CFD and forex trading have benefits but awlays involve risks. We can minimise these risks by knowing the fundamentals of trading and the market we are entering.
What Is a CFD?
A contract for difference is a contract or agreement between two parties to speculate on the price movement of a chosen financial asset, like stocks, indices, commodities, or currencies.
The term “speculating” in trading jargon means doing financial transactions while considering the benefits and risks involved.
Parties trading CFDs don’t exchange or own assets. As such, CFDs are considered derivative trading instruments.
Parties bound by a CFD contract speculate on the difference between an asset’s opening and closing prices at a specified time.
How Do CFDs Work?
CFDs involve two trades, which entail buying and selling. Don’t get confused with the terms “buying and selling” because CFD trading doesn’t require buying or selling actual assets.
Another term used for these two trades is “going long” and “going short.”
The first trade is when you buy. It means you’re opening a position because you believe the underlying asset’s price will rise at the end of the contract.
The second trade is when you sell. It means you’re closing a position you’ve opened, believing prices will soon fall.
What’s speculated in CFD trading is the price movement of the underlying asset between opening and closing trades. The CFD trader profits from the price difference between the opening and closing trades.
Example of Buying a CFD on a Currency Pair
To better illustrate how the CFD buying trade works, let’s choose a currency pair as our underlying asset.
A currency pair, or forex pair, is a quotation of two currencies, like EUR/USD (Euro/U.S. dollar) or GBP/USD (British pound/U.S. dollar).
Let’s say you want to buy CFD units for GBP/USD. You’re opening a position in the forex market but not buying actual currency.
In this pair, the British pound (GBP) is mentioned first before the U.S. dollar (USD). It means that you expect that the price of the GBP will rise at the end of the contract.
Suppose the opening price for this CFD currency pair position is $1.15000, and at the closing position, the rate rose to $1.15500.
In that case, you subtract the opening price from the closing price, and the difference of $500 is your gross profit.
Example of Selling a CFD on a Currency Pair
As mentioned, selling means you expect the asset’s price to fall, so you’re closing a position.
Instead of betting on an asset’s price increase, you place your money on the asset’s decreased value at the end of a contract and sell or close the position.
The opening and closing prices are calculated, and the difference between the two prices will be your gross profit.
Advantages of CFDs
CFDs have become popular because of the benefits traders have enjoyed while dealing with this financial instrument. Here are some key advantages of opting for CFD trading:
In trading, leverage is the amount borrowed from a broker to fund a trading investment. Leverages can help traders who don’t have enough capital to open a position.
Once the trade closes, the broker receives the borrowed money, and the trader either earns a profit or experiences a loss.
CFDs traded on margin have higher leverage than traditional trading. Because of the high leverage, the margin requirement for many CFD trades is 2% to 20%.
Margin is the amount you have to pay if you want to open a CFD position. Usually, the margin amount is a percentage of the total asset’s value. You only need to deposit a portion of the total value according to the margin rate.
Global Market Access From One Platform
CFDs have opened the doors for individual traders to access the world’s major markets. With a single platform, investors can trade CFDs on diverse international financial markets.
No Shorting Rules or Borrowing Stock
Shorting or short selling is selling assets or securities whenever you feel their value is falling in the open market. One technique investors use is repurchasing the same asset at a lower price afterwards.
Shorting is not allowed in some markets. However, CFD instruments can be “shorted” anytime because the trader doesn’t own any physical asset.
Professional Execution With No Fees
Some CFD brokers provide the same professional service as traditional brokers but with no fees.
Most CFD brokers make money when the trader pays the spread, which is the difference between a financial instrument’s “ask and buy” prices.
No Day Trading Requirements
Day trading is simply trading done within the day. Some markets require traders to pay a minimum capital amount to day trade.
Markets use these requirements to limit the number of day trades made within specific accounts. However, the CFD market isn’t limited by day trading restrictions, so you can trade anytime.
Variety of Trading Opportunities
CFD brokers offer traders access to assets like stocks, indices, currency, commodities, and treasury. Traders and speculators can access a variety of financial instruments to trade instead of exchanges.
Disadvantages of CFDs
Online trading always entails risks and there are some disadvantages that come with CFD trading that traders should keep in mind. However, such drawbacks shouldn’t hinder newbie traders from learning about this financial instrument.
Understanding these disadvantages can help you prepare so you can mitigate potential risks. Here are some of the common disadvantages people experience when trading CFDs:
Traders Pay the Spread
One disadvantage of CFD trading is the spread cost, which a trader has to pay at the opening and closing of a trade. The spread cost, or the difference between an asset’s opening and closing price, may lessen the profit from every completed contract.
Weak Industry Regulation
The CFD market is not strictly regulated, so you may encounter brokers who are not credible. A CFD broker’s credibility comes from longevity and their reputation and financial position rather than liquidity or good standing with the government.
CFD trading has many benefits and risks. Such disadvantages include a lack of liquidity, a margin requirement, and leverage risks, contributing to the high costs and liabilities you have to cover.
So, before committing to CFD trading, consider the benefits and risks enumerated in this article.
What Is Forex?
The term “forex” comes from “foreign exchange” combined. As the name implies, forex is exchanging one currency for another. It is one of the most popular asset classes of the markets today.
How Forex Trading Works
Forex trading operates 24 hours in a global marketplace from Monday to Friday and is done over the counter (OTC).
OTC transactions don’t involve any physical exchange of assets. As these deals happen, a global network of financial institutions operates and monitors the market.
Forex works by trading a quotation of two currencies or currency pairs. A currency pair tells traders the current value of one currency relevant to another.
Currency pairs use a three-letter code, wherein the first two letters usually denote the issuing country. The third letter refers to the first letter of the currency’s name, such as USD (United States dollar) and JPY (Japanese yen).
In a currency pair like GBP/USD, the first three-letter code is the “base currency”, and the second is the “quote currency”.
The quote is a ratio between the pair. It tells the trader how much of the “quote” currency can purchase one unit of the “base” currency. For instance, for a GBP/USD pair, the quote is 1.06. It means that £1 (GBP) is worth $1.06 (USD).
Currency Pairs Are Divided Into Categories
There are three categories of currency pairs.
- Majors: Includes major forex currencies paired with the USD (GBP/USD, JPY/USD, or EUR/USD)
- Minors: Doesn’t include the USD (GBP/EUR or JPY/GBP)
- Exotics: Involves a currency of a developing nation paired with the USD
Liquidity is a crucial aspect of forex trading. It refers to how easily you can buy and sell a specific asset or security. Currency pairs of countries that have healthy trading relationships are very liquid.
On the other hand, countries with poor trading relationships tend to be less liquid or not marketable.
Major and minor currency pairs are liquid in varying degrees. Traders can trade these currency pairs anytime because their spread is narrow.
It means you don’t have to wait long for a favourable price movement to cover trading costs.
However, for exotic currency pairs, price movements are larger and longer. You may need to wait for extended periods to cover trading costs. The longer you keep a position open, the more volatility or price fluctuations you’ll experience.
What’s the Difference Between a Futures Contract and a CFD?
Futures are contracts or agreements between traders to buy or sell assets or securities at an agreed price and at a specified time.
Though futures and CFDs both trade price movements and not assets, there are critical differences between these two. Here is a simple comparison between these trading instruments.
|Contracts for Difference (CFDs)
|Mostly traded in an exchange
Have longer carrying periods
Brokers of futures contracts act as an intermediary
Have an expiration date
|Offered over-the-counter (OTC)
Are short-term speculative products
CFD issuer acts as a counterparty
Don’t have an expiration date and can be closed at any time
Disclaimer: The products or services discussed in this section may not be offered by Taurex and may only be listed here for educational purposes.
What Are Forex CFDs?
Forex CFDs allow you to speculate on a currency pair’s price movement at the given date instead of owning the asset. Forex CFDs use leverage for traders to enter the market.
Is There Forex Trade on CFDs?
There is forex trade on CFDs. Aside from the exchange of currencies, many traders use CFDs when trading forex because CFDs are leveraged derivative instruments. You can speculate on price movements over time.
You can trade long or short so long as the price moves according to your expectations. If the price moves up, and you’ve placed your trade in a rising currency pair, you’ll profit. However, if it falls, then you lose money.
Forex vs. Forex CFDs
Forex trading and forex CFD trading differ. Forex trading focuses on currency trading or the exchange between two paired currencies. The profit is based on the exchange rate of the currency pair.
However, forex CFD trading speculates on a currency pair’s price movement. Instead of exchanging currencies, your cash-settled profit is based on the difference between a currency pair’s opening and closing prices.
CFDs vs. Forex: Key Similarities
CFDs and forex are popular in the online markets. The following topics tackle these two trading types to help you understand their similarities and differences.
CFD and Forex Trading Have a Similar Trade Execution Process
CFD and forex trading have similar price action strategies to enter and exit rising (bullish) or declining (bearish) markets.
Also, both types can be made over the counter using similar charts and pricing strategies. Furthermore, these instruments can be traded on online trading platforms.
You Don’t Need to Own Underlying Assets
CFDs and forex trading don’t require traders to own an underlying asset. CFDs focus on price movement speculations that don’t involve asset buying.
Similarly, forex traders don’t buy or sell physical money. Instead, they make directional “bets” on the exchange rate between currencies.
Potential to Trade Long and Short
CFD and forex trading can speculate on rising or falling price movements. As such, trading long and short is possible.
Long-term trading means buying and then selling an asset to profit from an upward price movement. Short-term trading means selling assets because of a downward price movement and repurchasing them at lower prices.
Use of Margin and Leverage
CFDs and forex traders use margins and leverage in their transactions. Margins are usually represented by a percentage that differs depending on the market.
Meanwhile, leverage levels depend on the offers given by a CFD or forex broker. In both cases, a trader doesn’t need a sizable capital to start trading. However, note that using margin and leverage can involve high risks.
Both Instruments Don’t Pay a Commission
CFDs and forex markets don’t attract commissions. Traders cover the spread— the difference between the ask and bid prices. While other expenses might apply, commissions are not part of the equation.
Available Educational Resources
Both experienced and novice traders can access an increasing array of educational resources.
Some brokers provide educational resources that tackle trading strategies, risk management, technical analysis in trading, and even a demo account for practice.
Both Markets Offer High Levels of Liquidity
Both CFD and forex markets exhibit high levels of liquidity. It means that you can fill in an order at any time. Also, unlike other trading instruments, you can enter or exit any CFD or forex position anytime.
High liquidity doesn’t necessarily mean all orders can be executed at any price without slippage in volatile markets.
CFDs vs. Forex: Key Differences
Here are the differences that set CFDs and forex apart. Understanding what makes these two trading options unique can help traders focus on trading decisions that fit their style.
Choice of Trading Instruments
CFDs and forex use different trading instruments or assets. CFDs provide traders access to numerous assets like shares, ETFs (exchange-traded funds), and currencies.
An ETF is a pooled investment security similar to a mutual fund.
On the other hand, forex only allows you to trade on currency pairs like GBP/USA, JPY/USA, and EUR/GBP.
The Cost of Trading
CFDs and forex trading have spread costs, so traders may need to pay these extra fees. Factors like marketing conditions and broker fees also contribute to increased trading costs.
An example of additional fees a CFD trader has to consider is the “rollover fee”. You pay this service charge when you want the broker to hold your contracts or positions overnight.
Global economic factors and geopolitical events may dramatically affect forex markets. Shifts in job markets, changes in monetary laws and policies, and even political unrest can affect the price movement of currency pairs.
For CFD trading, supply and demand and the trends of specific business sectors can influence the market. One example is the demand for renewable energy, which opened the door for investors to access this rising market.
Size of Traded Contracts
The standard lot size for currency pairs is 100,000 units. However, brokers can offer leveraged trading for smaller lots. Examples of small lots are nano (100), macro (1,000), and mini (10,000) lots or units.
For CFDs, contract sizes vary between markets. Let’s say the metals trade contract size is 100oz. So, CFDs for metals would start at a contract size of 100oz.
CFDs and the forex market have different trading periods. Forex traders can do their transactions 24 hours a day, from Monday to Friday. On the other hand, the CFD market is open even on the weekends. However, some markets are only available during specific periods.
Factors in Deciding Between CFDs and Forex
When you start trading, you must know the vital factors before you trade CFDs or go with forex. Consider the following before committing to any trading opportunity.
The forex market is limited to currency pairs. Traders can only check the currency price movements of different countries.
There’s not much diversity in the forex market as the focus is on currency exchange. It may be convenient for traders who want to concentrate on a few assets.
However, the CFD market involves a wider range of assets. You can trade commodities, indices, shares, ETFs, and forex.
A trader has to consider more factors to cover the different assets involved in CFD trading.
CFDs have limited availability because they’re prohibited in some countries. For instance, in the United States, CFDs are banned. Still, they’re allowed in Europe, Australia, the Asia-Pacific, and the United Kingdom.
On the other hand, forex trading is available worldwide because you can trade currency pairs through regulated exchanges or indirectly through brokers.
The price of CFDs is based on the supply and demand of the underlying asset. Higher asset demand equals higher demand for the related CFD.
Traders in the CFD market can observe the underlying asset’s movement to determine price movements.
Government policies, geopolitical events, and economic fluctuations influence forex markets. These factors affect the price movement of currencies.
CFDs are the better option if you’re a trader who wants to focus on price movements. However, forex might be the better choice if you’re more into the fundamental analysis of market conditions.
Forex CFDs: The Essentials
To be successful, any trader has to be knowledgeable about the trading essentials in their preferred market.
Forex CFDs are an interesting example because they combine CFDs, one of the most popular derivative products, and forex, one of the most traded financial markets.
Understanding how this combination works can give you an advantage in this trading market.
What’s the Difference Between Forex and CFDs?
As mentioned, forex involves currency trading, while CFDs are traded based on the price movement of an underlying asset. However, both forex and CFDs don’t require ownership of physical assets, like actual money or stocks.
Forex Is Traded in Pairs and Mimics the Underlying Asset
Forex trading always involves currency pairs. You’re always buying and selling the base currency you think will increase in value in a pair. The trading instrument is designed to mimic the underlying asset’s movement.
Forex CFDs Trade in the Quote Currency
Forex CFDs trade within the current monetary value of the currency pair, and you trade in the quote currency. For instance, when trading GBP/USD, you’re trading in U.S. dollars.
Spot vs. Options for Forex CFDs
Forex CFDs trade on the spot market, meaning you trade based on the current price.
You can also trade forex CFDs using options, which gives you the right, but not the obligation, to sell currency pairs before an agreed-upon date. Such periods include daily, weekly, monthly, and quarterly options.
There are differences between forex CFDs spot and options trading. Spot forex markets have no expiration date but have overnight funding charges when a position is left open for more than a day.
On the other hand, forex options have an expiry date but have no overnight funding charges. Another difference is the number of assets to trade with. Spot forex has 80 currency pairs, while forex options only have nine.
Spot Forex CFDs Are Traded in Contracts
Forex CFDs are traded in contracts. You can calculate the gain or loss of a CFD forex trade by multiplying the total number of contracts by the value of each contract.
You then multiply the product by the difference in points between an underlying asset’s opening and closing prices.
How to Trade Forex CFDs
The following is an example of how to start trading with forex CFDs. You can visit EverythingTrading.com to learn more about trading, especially with CFDs.
Learn All About CFD Trading and Forex Trading
It’s always best to have trading knowledge before risking any funds in forex or CFD trading.
People who dive into trading without understanding its mechanics may commit costly mistakes that can result in severe money loss.
Open and Fund Your Live CFD Account
Once you’re confident with the basic knowledge you have about trading, you can start opening and funding a live account. You may need to choose a broker that provides the type of trading you prefer.
Fill Out a Simple Form
Most brokers will have you fill out a simple form when creating an account. You only need to provide the required information, and you’re good to go.
Get Instant Verification
You’ll get verification after signing up and before you start trading. During the verification process, you may be asked for personal information.
Fund and Start Trading
After verification, you can fund your trading account using different deposit methods. Some brokers allow bank transfers and the use of credit and debit cards.
Forex trades involve a contract or lot size regardless of the currency pair. The standard contract or lot size is 100,000 units per currency pair.
Still, some brokers provide smaller contract sizes, making trading more accessible to traders with different budgets.
Global macroeconomic factors can influence forex performance, while business trend changes that affect supply and demand may influence CFDs. A combination of these factors has an impact on forex CFDs.
The Cost of Trading
CFD trading’s main cost is the spread cost, which the trader needs to cover when opening and closing a contract.
Choose Your Currency Pair to Trade
When trading forex, you need to choose a currency pair. You have 80 currency pairs to deal with, including majors, minors, and exotic pairs.
Decide Whether You Want to Trade Spot FX CFDs or CFD FX Options
You may need to choose whether to spot trade or go with CFD forex options. Remember that spot trades mean you’re trading with the current market prices with no expiry dates.
However, with options, you have the right but not the obligation to buy or sell a security or asset at a predetermined price when it moves past that price within a specific period.
Open Your First Forex CFD Trade
Once you’re all set, you can start trading and open your first forex CFD position. Always follow sound trading strategies and principles. It’s best to absorb trading knowledge from experts in the market.
Monitor Your Position
After opening a position, you should monitor it constantly. Trading always involves risks, so you should always check the status of your position.
Types of Trading Strategies for Forex and CFDs
There is more than one way of analysing and developing strategies for forex and CFDs, including the following:
- Fundamental analysis: This involves checking and considering the difference between economies and how it affects the relative strengths of each country in a currency pair. Factors that require fundamental analysis include interest rates, trade balances, and money supply.
- Technical analysis: This involves understanding the price action of a currency pair. Traders use indicators to identify possible entry points.
- Scalping strategies: These involve strategic predictions for short-term price movements that may last from minutes to seconds.
Why Do Traders Fail?
A trader or any retail investor account fails because they don’t understand the risks involved. Sometimes, they may also lack strategy.
If not appropriately handled, CFDs are complex trading instruments with a high risk of rapid money loss due to leverage. You need to consider how CFDs work and whether you can afford the high stakes.
Is Trading Safe?
If by safe you mean safe from getting ripped off by scammers, then there are many legitimate brokers you can choose to start your trading journey with. However, as mentioned, trading is risky, and you should always tread carefully.
The bright side is that many people are developing strategies to help newcomers get into this industry fast. You just need to absorb what they teach, use what works for you, and reap the benefits.
Is Forex or Forex CFD Trading Illegal?
Different countries have various regulations about brokers and leverage amounts available to clients.
Both forex and forex CFDs are trading opportunities that are not allowed in select countries. For instance, CFDs are generally prohibited in the United States.
Why Trade With Taurex?
You can trade with a trusted broker like Taurex. Credible brokers have credentials that follow policies established by various regulating bodies.
However, always remember that using these financial services involves risks. Your investment’s value may fluctuate, resulting in money loss.
As a trader, you are responsible for understanding and accepting these risks in exchange for the potential benefits this type of trading provides.
Here are some terminologies used in this article and other trading resources about CFDs and forex trading.
What Are Lot Sizes? And How Do You Calculate Position Size?
A lot is a standardised trade size or unit for forex. One lot is 100,000 units of base currency. To calculate the position size, all you need to do is to multiply the currency pair rate by 100,000.
For instance, the rate for EUR/USD is 1.1019. You need to pay $110,190 (1.1019 x 100,000). Some brokers offer small lots (mini, micro, and nano).
What Does Spread Mean?
The spread is usually the difference between a specific asset’s highest buying price and its lowest selling price. You must know the spread in a position because this is the cost a broker charges for a financial transaction.
What Is a PIP?
A PIP or point in percentage is the measurement of slight changes in the price movement of a currency pair. A PIP is usually the last decimal place in a quoted price.
For instance, a EUR/USD pair rose from $1.1030 to $1.1031. The increase of $0.0001 is one PIP.
Bulls and Bears: Long Positions vs. Short Positions
Bull traders are optimistic and expect asset prices to rise. Bulls often open long positions in forex or forex CFD markets. On the other hand, bear traders expect prices to fall and open short positions.
What Is Leverage?
Leverage in CFD trading is the trader’s ability to open a trading position without paying for the total value upfront. With the help of leverage, you only need to pay a portion of the entire position’s value, called a margin.
Pros and Cons of Using Leverage
Leverage is a handy tool traders use to enter into CFD trading. However, it also increases your risk.
The main benefit of leverage is gaining the same market exposure by depositing a fraction of the trade’s total value. Traders can use the rest of their capital on other investment opportunities.
The main risk of leverage is that it can magnify losses. When you open a leveraged position, you must maintain equity or an initial margin. A margin call happens if the market moves against your expectations and dips below the margin.
The trader must deposit additional money to keep the position open, or the broker may close the trading position and incur significant losses.
Frequently Asked Questions (FAQs)
- What’s the difference between forex CFDs, spread bets, spots, and options?
Forex CFDs are derivative instruments where traders speculate on a currency pair’s opening and closing price difference instead of the exchange rate between the currencies.
Spread bets speculate on the direction of an underlying asset’s price movement.
The difference between spots and options is the time traders conclude a trade. In spot trading, financial instruments are traded immediately.
However, in options, a trader has the right but not the obligation to buy or sell a financial instrument in the future.
- Is CFD trading better than forex?
From the perspective of trading choices, CFD trading has more assets to trade than forex. By trading more underlying assets through leverage, you may improve your portfolio with CFD trading.
Forex trading focuses on currency pairs that are influenced mainly by the trading relationship between countries.
- Can I trade forex without a CFD?
You can trade forex even without using CFDs. When you trade purely on forex, you’re focusing on currency pairs. In spot forex, you can trade with 80 currency pairs.
Considering all currencies, you’re faced with over 2,300 currency pairs. However, only 5% of those pairs are usually traded because of their liquidity.
The remaining 95% of currency pairs are rarely traded because they can’t be readily exchanged.
- CFDs vs. forex— which one should I choose?
It depends on your objective as a trader. If you want exposure to a wide range of assets with leverage, you can choose CFD trading. However, if you would like to focus only on currency trading, then forex is the choice.
- How is forex taxed?
Taxes are based on the regulations in the country where you will execute your trades. For instance, the standard tax rate for forex capital gains in the United States, as stated by the Internal Revenue Service (IRS), is 60/40.
It means that 60% of your gains are taxed at 15%, while the remaining 40% are taxed at your income bracket.
The IRS is the federal agency that handles U.S. tax laws and collections.
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- What Is Forex Trading? A Beginner’s Guide
- What Is a Currency Pair? Major, Minor, and Exotic Examples
- A Basic Guide To Forex Trading
- Futures Contract Definition: Types, Mechanics, and Uses in Trading
- What Is Spot Trading and How Do You Profit? How It Works