Are CFDs Better Than Forex? Pros and Cons Compared

Forex and contracts for difference (CFDs) are still two of the most popular trading instruments in the market. Traders can speculate on the price movements of a variety of financial instruments, including currency pairs, indices, commodities, and stocks, through CFDs. The foreign exchange market, where traders convert one currency for another in the hopes of making money on changes in the exchange rate, is the main focus of forex trading.

However, without really owning the underlying assets, CFD trading enables traders to speculate on the changes in value of a range of financial assets. This article offers a thorough introduction to both forex and CFD trading, covering the essential ideas, significant distinctions, and fundamental trading approaches.

We are going to compare these two instruments, each of which has unique advantages and disadvantages. Let’s examine each one’s distinctive qualities.

What are CFDs?

CFDs are a type of derivative trading instrument that lets traders speculate on how much financial assets like equities, commodities, indices, or currencies will fluctuate in value. Participants agree to swap the difference in the value of an asset between the contract opening and closing in CFD transactions rather than exchanging the actual assets.

This removes the requirement to possess the underlying assets. By predicting price directions, CFDs give traders the chance to potentially profit from market movements, whether they are upward or downward.

How do trading in CFDs work?

Investors can speculate on the price movements of various underlying assets through CFD trading without actually owning them. For example, traders can buy or sell CFDs linked to market prices instead of physically buying or selling gold or silver.

A trader may take a long position in the asset and sell the CFD at a higher price later if they believe that product prices will rise.

In contrast, if they anticipate a drop in product prices, they can open a short position on the asset by effectively borrowing it, selling it through a CFD, and then repurchasing it at a lower cost in an attempt to profit from the price difference. Short selling is the term used to describe this activity.

What is foreign exchange?

The global currency market is referred to as forex, or foreign exchange. It always involves trading currency pairs and focuses on converting one currency into another. In foreign exchange trading, a currency pair denotes the relative value of two distinct currencies, with the value of one currency being quoted against the other.

How does trading in forex take place?

Forex trading involves the purchase and sale of currencies according to their respective exchange rates, without the need for actual currency exchange. It works similarly to exchanging money before going overseas, but it happens digitally via trading platforms in an over-the-counter (OTC) market.

Traders will buy a currency pair when they believe its value will increase and sell it when they believe it will decrease.

The foreign exchange market is open around-the-clock, without a physical location, and trades are made electronically between traders worldwide. Sydney, Tokyo, London, and New York are the four main trading sessions that make up this market. Each has its own trading patterns and liquidity levels.

Financial products (CFDs) in forex trading

Forex trading involves currency pairs. It’s critical to understand the three-letter codes used for all currencies. The U.S. dollar (USD) is used in the vast majority of forex transactions out of all those codes. The euro (EURO) is the second most traded currency in the foreign exchange market, after the US dollar.

The following currency pairs make up 75% of all forex market trading:

USD/EUR
USD/JPY
USD/USD
AUD/USD
USD/CNY
NZD/USD
USD/CAD
USD/CHF

CFD Trading Products

CFDs give traders access to a wider variety of instruments than forex does. Among them are:

Indices
Commodities
Stocks
Currencies

To make sure you’re comfortable with your chosen instrument, it’s best to start with a demo account before selecting one to start CFD trading. By doing that, losses in the live markets will be reduced.

Forex & CFDs: similarities

1. Trade execution process

Similar price action approaches can be used to enter and exit markets that are bullish or bearish. Additionally, you can trade Forex pairs and CFDs over the counter on the same platform with comparable pricing schemes and charts.

You can trade CFDs and currency pairs without them being listed on exchanges. Alternatively, you can choose to trade both instruments using an online platform for CFD trading.

2. No ownership requirement for underlying assets

CFD trading is possible even if you don’t own the underlying assets. All you do is speculate how their prices will change. For example, it is possible to speculate on the price movement of the EUR/USD pair without actually purchasing any euros or disposing of any US dollars.

3. No commission is paid on either instrument

Commissions are not charged when trading contracts for differences or forex markets, in contrast to other instruments. Traders only have to pay the spread, the difference between the asking and offering prices. Aside from commissions, there might occasionally be other expenses.

4. High liquidity levels are available in both markets

The liquidity of both CFDs and forex markets is very good. This implies that you can place your order whenever you want and at the price you choose. It also implies that you are free to change the terms of any forex or CFD position at any time.

Forex & CFD differences

1. Trading instrument options

Compared to forex, which is restricted to currency pairs, CFDs provide access to a larger range of assets.

Major currency pairs such as GBP/USD, AUD/USD, EUR/USD, USD/JPY, USD/CHF, USD/CAD, USD/HKD, and EUR/GBP are usually accessible through forex brokers.

Trade CFDs to gain access to a wide range of markets and currency pairs, including stocks, bonds, commodities, indices, and exchange-traded funds.

2. Cost considerations

Spreads are a part of trading forex and CFDs. However, as a CFD trader, you might incur additional costs. Your trading costs can be impacted by variables such as your broker and the state of the market. For instance, holding fees are a typical extra expense associated with CFDs. Should you decide to hold any contracts overnight, your CFD broker will charge you holding fees. Commissions from the transaction costs you pay when trading share CFDs are another typical extra fee.

3. Market influences

Trade changes, geopolitical concerns, changes in the labour market, and adjustments to monetary policy all have an impact on foreign exchange markets. Concerns about climate change have an impact on supply and demand dynamics as well as trends in industries like renewable energy, which affect CFD markets.

4. Contract sizes

The typical lot size in forex trading is 100,000 units, though smaller lots are also an option. CFD contracts come in different sizes. Metals trade in 100-ounce standards, while shares are usually traded in single-share contracts.

5. Trading hours

CFD trading hours differ from those of forex markets, which are open around the clock. While other CFDs can only be traded during specific market hours on weekends, forex CFDs are accessible around-the-clock.

Disclaimer:
This information is not considered investment advice or an investment recommendation, but instead a marketing communication. IronFX is not responsible for any data or information provided by third parties referenced or hyperlinked in this communication.