Are CFDs part of forex?

CFD trading is very similar to forex trading, but there are also some key differences. A CFD (Contract for Difference) is a financial derivative that allows traders to speculate on the price movement of the asset being traded, without owning the instrument. CFD trading covers a diverse set of financial markets, such as indices, stocks and metals.

Forex, or foreign exchange trading offers only foreign currency trading, where currencies are bought and sold in the forex market. With a daily trading volume of more than $7.5 trillion or more, the forex market is the largest and most liquid market in the world.

Are CFDs part of forex? Let’s take a closer look at these two instruments.

Forex trading

Forex trading involves buying and selling of currencies, aiming to profit from changes in exchange rates. The forex market is a decentralised market, meaning currencies are traded over-the-counter (OTC) through electronic trading platforms. The forex market is open 24 hours a day, five days a week, except for holidays. The main players in the forex market include banks, forex brokers, financial institutions, and retail traders.

Basically, forex trading involves speculating on the currency exchange rate between two currencies, whether it will increase or decrease. You are not actually buying or selling currencies. For instance, the EUR/USD exchange rate implies the relative price of the euro in terms of US dollars.

Contracts for Difference (CFDs)

A CFD is a type of financial derivative that allows traders to speculate on the price movement of an underlying asset, such as stocks, commodities, indices, or currencies. With CFD trading, traders enter into a contract with broker and agree to exchange the difference in the asset’s price between the opening and closing of the position. If the price of the asset increases, the buyer profits from the price difference. On the other hand, if the price decreases, the seller makes a profit.

Pros of trading CFDs

Leverage (Leverage)

CFDs can be traded using leverage, allowing traders to control larger positions with a lower initial investment. However, while leverage can increase your profit potential, it can also increase your losses.

Trade in both rising and falling markets

Unlike traditional investing where you can only profit from rising markets, CFDs allow you to profit from both rising and falling markets. If you think prices will fall, you can go short (sell). But if you think prices will rise, you can go long (buy).

Diversification

CFDs cover a wide range of underlying assets, including stocks, currencies, indices, and commodities. With such a large range of instruments, traders can diversify their portfolios and capitalise on trading opportunities across multiple asset classes.

Lower costs

CFDs do not involve ownership of the underlying asset, which means you don’t need to be concerned about storage, delivery, or ownership rights. CFD trading simplifies the process, allowing you to focus on speculating on price movements rather than the complexities of the asset itself.

The relationship between CFDs and forex

Let’s consider the question: Are CFDs part of forex trading? While CFDs can be used to speculate on currency pairs, CFDs cover a wide range of assets beyond currencies. However, many traders use CFDs for forex trading because of the liquidity and volatility of the currency markets. When trading forex with CFDs, traders can use leverage and have the ability to go long or short.

In addition, both types of trading use the same trade execution method. Traders can easily enter and exit markets that are rising or falling. Furthermore, the same platform is used for CFD and forex trading, and both use similar charts and pricing strategies. In both cases, trades take place over-the-counter (OTC).

An OTC market involves a network of banks that operates only electronically and without a physical location or central exchange. Another thing that is similar between CFD and forex trading is there are no commissions or other financial costs involved; the only cost is the spread.

In CFD and forex trading, you don’t own the underlying asset. For instance, if you buy GBP/EUR in FX trading, you are speculating on their exchange rate instead of buying GBP and selling Euros. It’s the same with CFDs on the FTSE 100. You’re not buying the stocks that make up the FTSE index, you’re speculating on the index’s price.

Price factors

The factors that influence price movement in CFD trading vary depending on the market the asset belongs to. For example, the prices of crude oil CFDs are usually affected by supply and demand or the time of year. Similar to stock prices, equity CFD prices can be influenced by business factors or company-specific events, such as earnings or acquisitions.

On the other hand, fundamental factors such as economic growth and monetary policy expectations have a major impact on price movements in the forex market.

In addition, risk sentiment and geopolitical tension can also affect price movement, and sometimes even environmental factors can affect how prices change.

Trade execution

In both CFD and forex trading, trades are executed in an OTC market under a decentralised exchange. Neither type of trading involves the physical transfer of assets. Profit or loss are calculated based on the opening and closing prices.

Trade costs

With forex trading, costs are generally determined by the bid-ask spread set by the broker. In CFD trading, transaction costs can involve commissions, which vary based on the underlying asset.

If you keep a CFD position open overnight, you may incur overnight financing costs which consist of a daily charge based on the size of the contract.

Trades that are kept open for much longer are subject to increasing interest charges, which can significantly reduce your trade returns. On the other hand, the trader usually bears the financing costs associated with short CFD positions.

Brokers offering commodity CFDs typically base their contract pricing on the futures market, which means there may be expiry dates and settlement costs too.

If you’re thinking about CFD trading, it’s better to trade markets that you are familiar with. As with forex trading, it’s a good idea to practise with a demo account before you risk real money in markets you are not very familiar with.

How to start trading CFDs or forex

Continuous education is essential for any type of trading. Even if you have some experience already, you can always enhance the skills you have.

You can start by opening a free demo account with an online forex broker. As you gain knowledge and improve your skills, you will find it easier to enter more markets.

Understanding economics and monetary policy is also important since they both influence currency values. You can find plenty of online resources, such as articles and trading videos, to learn more.

Summary

In conclusion, while CFDs and forex are different financial instruments, they are closely connected. CFDs offer a flexible and efficient way to speculate on price movements in different financial markets. However, the forex market focuses only on currency trading while CFDs offer access to a wide range of assets with leverage, including forex.

An important point to keep in mind is that both types of trading carry significant risks, which must be managed carefully. In the end, the decision to trade CFDs or forex depends on your goals, risk tolerance, and investment approach.

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.