Contracts for difference (CFDs) and forex have important similarities and differences that traders should be aware of. Both can be quite helpful for the purpose of speculation, and by learning more about the two, investors can decide which one best suits their objectives. In some cases, traders may opt to use both, depending on the situation.
CFDs are contracts between traders and brokers in which they agree to exchange the difference between the entry and exit price of an underlying asset. While these contacts can be used to speculate on the foreign exchange markets, they can also be used to bet on assets like precious metals and oil, in addition to market factors such as indices.
When trading CFDs, investors have significant flexibility in terms of choosing both the currencies they trade and also the increment values they want to use. The profit or loss that investors receive from these arrangements is calculated by taking the difference between the entry and exit prices and multiplying that figure by the number of CFD units.
CFDs may seem sophisticated and complex. Forex, which involves trading different currencies against one another, is a bit more straightforward. This market is also one of the largest available to investors, and it has daily trading volume of more than US$5 trillion (£3.8 trillion).
Similarities Between CFDs And Forex
Both CFD and forex trading avoid the transfer of physical assets. They both trade over the counter (OTC), meaning that their transactions are decentralised and take place through a network of financial institutions. Their trades are also typically executed the same way.
Further, they trade through the same platforms, which has prompted some service providers to offer platforms traders can use for both CFDs and forex.
In terms of access to leverage, CFDs and forex offer access to margin. The margin that investors can harness when trading CFDs is generally stated as a fixed percentage. For example, if a contract has a margin of 10%, that means a trader can put down 10% of the contract's total market position value and borrow the remainder.
The margin used in forex trading, alternatively, is generally as a ratio, such as 1:5 or 1:10. For example, if a trader has a leverage ratio of 1:5, they can enter into £5 worth of trades for every £1 in their account.
Another similarity between CFDs and forex is that their trading costs are at least partially based on the spread, which is the difference between the entry and exit points.
Differences Between CFDs And Forex
There are several notable differences between CFDs and forex.
As discussed previously, CFDs offer a bit more flexibility by offering a range of contracts with different currencies and increment values.
Another major difference between the two is their key price determinants. The price of CFDs, for example, depends largely on the supply and demand for the underlying asset being traded. The value of currencies, on the other hand, relies far more on fundamental factors. These can include the strength of key economic indicators and and whatever policies are in place, among other factors.
In addition, the forex market is open 24 hours a day/5 days a week, offering investors around the world access to trade at their leisure. The trading times for CFDs vary based on the underlying market, commodity or asset. You can learn more about those hours in FXCM's CFD guide.
While CFDs and forex have many similarities, they also have their key differences. By knowing what makes these two different, investors can make better-informed decisions and decide how best to incorporate CFDs and forex into their trading strategy.
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