When it comes to trading, there are two prominent methods that traders often use: foreign exchange (FX) trading and contracts for difference (CFD) trading. While Forex trading involves buying and selling currencies, CFDs are unique Forex tools that allow traders to speculate on the price movements of various financial instruments without actually owning the underlying assets. It’s essential for traders to understand both the similarities and differences between these two financial markets. By doing so, they can make informed decisions and choose the trading method that aligns with their goals and preferences.
Similarities between Forex & CFDs
CFD trading and Forex trading share several similarities:
- Firstly, both CFD and Forex involve a similar process for executing trades. Traders can conveniently enter or exit the market, regardless of whether it’s moving upward or downward. This allows them to take advantage of various market conditions and profit from both rising and falling prices.
- Both CFD and Forex trades share a common feature in terms of their execution platform, charts, and pricing methods. Traders engage in both types of trading on the same platform, utilising charts and tools that have a similar appearance. This familiarity simplifies the transition for traders who wish to explore both CFD and Forex markets. Furthermore, both CFD and Forex trades occur in the over-the-counter (OTC) market. This means that trading activities occur electronically between participating banks without a central exchange or physical location. The OTC market operates through a network of financial institutions that facilitate the buying and selling of CFD contracts and Forex currency pairs.
- In both types of trading, the primary cost incurred by traders is the spread. This stands in contrast to other trading instruments that often involve additional fees. This offers transparency to CFD and forex brokers as they can easily factor in spreads when trying to determine the exact amount of profit or loss they could make. There are many profit calculators that work in this way. They show you the potential profit or loss after considering spreads. Moreover, the absence of finance and other types of fees reduces the overall trading costs, which is especially advantageous for traders who engage in multiple trades, as they can save on their total trading expenses.
- In both Forex and CFD trading, traders do not actually take ownership of the underlying asset being traded. For example, purchasing a currency pair like EUR/AUD does not involve physically buying Euros and selling Australian dollars when engaging in Forex trading. This type of trading is commonly referred to as non-deliverable trading. Similarly, in CFD trading, let’s consider a trader who purchases 1 million barrels of oil. In CFD trading, the trader is not concerned with the logistical aspects, such as transportation, storage, or the subsequent selling of the physical oil. Instead, the focus is solely on the difference in the market price of oil between the time of the transaction with the broker and the closing of the trade. This non-deliverable nature of online trading in Forex and CFDs eliminates the complexities and responsibilities associated with physically handling the traded assets. Traders can solely concentrate on speculating on price movements and aiming to profit from the price differences.
- Contracts for Difference (CFD) and foreign exchange (Forex) trading allow traders to use margins, which can significantly increase their leverage. In CFD trading, leverage is often expressed as a percentage. When a trader enters into a CFD contract, they are typically required to deposit a portion of the total value of the position, known as the margin requirement. For example, if the margin requirement is 10%, it means the trader only needs to put down 10% of the total value of the position as an initial deposit. The remaining 90% can be borrowed from the broker. Similarly, Forex trading also allows traders to use leverage. Forex brokers offer leverage ratios that specify the amount a trader can borrow relative to their initial investment. For example, a leverage ratio of 1:100 means that for every $1 of the trader’s capital, they can control a position worth $100.
Differences between Forex & CFDs
- The main differences between CFD trading and Forex trading lie in the variety of contracts and the focus of the markets involved. CFD trading encompasses various contracts covering diverse markets, including indices, energy commodities, and metals. On the other hand, Forex trading focuses solely on currency trading, involving the exchange of one currency for another. In CFD trading, traders have the flexibility to choose from various types of contracts based on different underlying assets. These contracts may vary in terms of the increment value and currency type, depending on the country of origin for the underlying asset. This allows traders to access and trade different markets and instruments through a single platform. In contrast, Forex trading revolves around trading one currency against another currency. The trading pairs consist of two currencies, and the aim is to speculate on the exchange rate between them. Unlike CFD trading, Forex trading follows standardised lot sizes, ensuring uniformity in trading positions.
- One notable difference between CFD and Forex trading is the factors influencing the respective markets. CFD trading is largely influenced by specific factors that pertain to individual commodities or trends within specific business sectors. Supply and demand dynamics play a significant role in determining the price movements of commodities traded through CFDs. For example, changes in oil production or demand for precious metals can impact the prices of corresponding CFD contracts. On the other hand, Forex trading is primarily driven by global events and macroeconomic factors. Currency exchange rates are influenced by a wide range of factors, including economic indicators, central bank policies, geopolitical events, and international trade dynamics. Major employment shifts, changes in interest rates, political developments, and trade agreements can significantly impact currency values and Forex trading.
- Another important distinction between CFD trading and Forex trading is the nature of the transactions and the parties involved. CFDs (Contracts for Difference) are financial derivatives involving entering into a broker contract. When trading CFDs, traders are not directly participating in the underlying market but rather speculating on the underlying asset’s price movements. On the other hand, Forex trading often takes place directly between two parties in the interbank market. It involves the exchange of one currency for another at an agreed-upon exchange rate.
- In CFD trading, prices are quoted based on the difference between the current price and the underlying asset’s future price, which are quoted in terms of pip. To find the value of each pip in dollars, you can make use of pip calculators that are easily available on most trading platforms. CFD brokers add their charge, known as the spread, into the difference between these two prices. Conversely, in Forex trading, prices are quoted in terms of the value of one currency relative to another currency. Forex prices are typically presented as currency pairs, with the value of the base currency being compared to the quote currency. For example, the price quotation for the EUR/USD currency pair represents the value of one Euro in terms of US dollars.
- In Forex trading, the lot size remains uniform regardless of the currency pair being traded. The standard lot size is typically set at 100,000 units of currency. However, brokers also offer smaller lot sizes such as mini, micro, and nano lots, which are 10,000, 1,000, and 100 units of currency, respectively. In contrast, CFD trading provides traders with a broader range of contract sizes, offering flexibility in trading various instruments. Depending on the specific CFD instrument chosen, the contract size can vary. For example, when trading CFDs on metals, one standard contract usually represents 100 ounces of the metal. This allows traders to tailor their positions to their desired exposure and risk management strategies.
To conclude, Forex is just one part of the broader CFD market, and they have a lot in common. Although Forex has its unique characteristics, it shares more similarities with other CFD markets than differences.
