What is a CFD in forex?

CFDs are a common form of trading, but they remain a somewhat elusive thing to grasp for some newer traders. In forex markets in particular, CFD are an everyday part of traders’ routines. That’s why it’s important to have a firm grasp of the term and what it means.

When asking the question: “What is a CFD in forex?” two answers arise. The first, more direct, answer pertains to trading currency pairs as CFDs, which is fairly common. The second, less obvious one, relates to CFD assets present in most online brokerages.

This article will tackle both of these questions in the hopes of giving traders a full understanding of the use of CFDs in forex trading.

What is a CFD

Before we tackle these questions themselves, let’s take a step back and make sure the base terms are entirely clear. CFDs are a type of derivative contract, which means they derive their value from market assets.

Essentially, they are a way for traders to conduct their routine without owning the instrument they are trading. Naturally, traders will ask why they wouldn’t want to own the asset, but the answer to that is a bit more complex.

Ownership of financial assets imposes strict rules and regulations by local financial authorities. For instance, if a trader from the UAE wants to buy Amazon stocks, they won’t be able to do so easily, since Amazon is a US company.

CFDs circumvent that by allowing this trader to make a contract with the broker to open and close a trade that will be equal in value to trading the actual asset, but without all the hassle. This allows CFD brokers to offer a wide array of top global assets in a single service.

The other reason traders would want to forsake ownership doesn’t have to do with ownership itself. Instead, it has to do with pricing. CFD brokers often have lower fees for low and mid-budget traders, creating a more favourable trading experience.

Obviously, the lack of ownership isn’t an upside by itself. However, forex & CFD brokers have worked to minimise the downsides while adding unique advantages. In modern markets, there is very little difference between trading in spot and CFD markets.

Is forex a CFD?

Foreign exchange markets, or forex, are closely tied to CFDs. Whether forex is a CFD itself highly depends on the broker that offers them.

For the vast majority of forex & CFD brokers, forex will be traded as a derivative. In that case, it will be a CFD asset tied to the value of spot forex markets.

Retail traders, in practice, are likely to experience no difference between spot and CFD forex trading. However, for brokers, it makes a huge difference. The first and most significant reason is that it’s much easier to get verified, as many regulatory bodies oversee CFD markets.

Next, it’s easier to organise the service itself to be more beginner-friendly.  Brokers that offer forex as CFDs often have lower barriers to entry, which include lower account minimum deposits. That allows them to garner a larger audience, and cater to small-scale traders, who make up the majority of retail traders.

CFD in forex brokerages

Now it’s time to jump to the other question posed at the start. While forex can be a CFD, and mostly is, other assets can be traded as CFDs as well. These can mostly be found in the same brokerages alongside each other.

Traders who want to craft a smart, diversified portfolio will include other assets besides forex. And like we mentioned earlier, CFDs allow traders to access top markets from around the world without any trouble at all. There’s no going through exchanges from other countries, it’s possible to simply purchase and sell the CFD at any time.

Let’s look at the most common asset types offered by such brokers and see whether trading them as CFDs makes any difference.

Stock CFDs

Acciones are perhaps where the differences between spot and CFD markets are most pronounced. That’s because stocks, in spot markets, pay out dividends, essentially a small payment for holding the stock.

Additionally, in spot markets, traders can become major shareholders and even sit on a company’s board. That’s, of course, provided that they purchase a large enough share of the company, which is out of reach for the vast majority.

When traders hear that, they may think that trading stocks as CFDs is much less viable. However, it’s important to note that dividend payments are fairly small for people who don’t hold a very large amount of shares. As such, CFDs remain a viable way to trade stocks for retail traders.

Commodities CFDs

Again, this is an asset class that has some functional differences between spot and CFD markets. However, these differences are unlikely to matter to anyone besides large corporations.

Commodities are generally divided into three groups:

• Metales
• Energies
• Agricultures

The one thing that they all have in common is that they are physical goods. In spot markets, when a trader purchases commodities, they have ownership over the actual goods purchased. In other words, that means that they can have them delivered if they wish to do so.

Naturally, this is a very costly process, and traders rarely need to use actual oil barrels and bars of gold. Again, CFDs allow the same purchasing power and pricing, making the difference negligible.

Indices CFDs

Indices are essentially stock collections, they usually evaluate entire market segments. They are very safe assets, at least the most commonly traded ones from major economies, as these countries generally tend to grow economically.

However, in spot markets, they suffer the same issue as stocks, as purchasing them outside their originating country can be difficult. As such, spot traders can often have limited access to spot indices like the S&P 500, Nasdaq, DOW, DAX 40, and FTSE 100.

And once again CFDs make that much easier. Most forex & CFD brokers have these assets in their trading instrument library. That makes it easier for traders outside global economic forces like the US and EU to add some security to their portfolios.

CFDs in forex: A perfect match

While some traders may feel strongly against CFDs, it’s undeniable that they have had a large and positive impact on broadening the trading scene. Along with forex, they have allowed smaller traders to enter the market and trade with full power. On top of that, they have made trading much more available and efficient across the world.

The main advantage CFDs (and, as an extension, forex as CFDs) have is accessibility. They allow brokers to create services where entry points are low, costs scale off of trade size, and most importantly, where anyone can access any trading instrument. That means traders won’t be stifled by their country’s borders, and can instead have a genuine trading experience.

And while some minor downsides do exist, they fade compared to the previous sentiment. CFDs allow traders to trade top global stocks, indices, and international energies in both long and short positions without any effort at all. Many traders have welcomed this chance, as proven by the significant online CFD trading community, which is bound to keep growing.

Exención de responsabilidad: 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.