If you’re considering diving into financial trading, chances are you’ve come across two buzzwords — CFD and forex. Here’s the deal: a contract for difference (CFD) is a specific financial tool, while forex serves as the market itself. They both let you take a stab at predicting the price shifts of various assets, but there are some key distinctions between them.

Stick around as we delve into the differences between CFD trading and forex, uncovering the unique traits of each.

What are CFDs?

CFDs, or contracts for difference, are financial derivatives that allow traders to speculate on the price movements of various assets such as stocks, commodities, indices, or currencies. Instead of owning the actual assets, CFD transactions involve agreeing to exchange the difference in price between the opening and closing of the contract.

This means traders don’t need to own the underlying assets to participate. By trading CFDs, investors can potentially profit from both upward and downward market movements.

How Do CFDs Work?

In essence, CFDs enable traders to speculate on price changes in assets without owning them directly. For example, instead of purchasing gold or silver, traders can buy or sell CFDs representing the prices of these commodities.

Traders can go “long” on an asset by buying a CFD, expecting its price to rise, and then sell the CFD for a profit.

Conversely, traders can go “short” by selling a CFD if they anticipate the asset’s price will decrease. This involves selling the borrowed asset with the intention of buying it back at a lower price to profit from the price difference, a strategy commonly known as “short selling”.

What is Foreign Exchange?

Foreign exchange, commonly known as forex or FX trading, involves the exchange of one currency for another. In forex trading, currencies are traded in pairs, with the value of one currency quoted against the other.

How Does Forex Trading Work?

Unlike physical currency exchange, forex trading occurs electronically through trading platforms in an over-the-counter (OTC) market. Traders speculate on the fluctuation of exchange rates to potentially profit. They buy a currency pair when they expect its value to increase and sell it when they anticipate a decrease.

The forex market operates globally, spanning different time zones, and remains open every day of the year. It consists of four major trading sessions in Sydney, Tokyo, London, and New York, each offering distinct trading characteristics and liquidity levels.

Similarities Between CFDs and Forex

1. Similar Trade Execution Process for CFD and Forex Trading

Trading both CFDs and forex involves a comparable process for entering and exiting bullish or bearish markets. You can utilize similar price action strategies and trade both instruments over the counter on the same platform, using alike charts and pricing methods. Neither CFDs nor currency pairs need to be listed on exchanges; they can be traded directly between you and your broker online.

2. No Ownership of Underlying Assets Required

In both forex and CFD trading, you’re not obligated to possess the actual underlying assets. Your focus is solely on speculating their price movements. For example, you can engage in trading the EUR/USD pair without physically owning Euros or selling US dollars.

3. Absence of Commission Charges for Both Instruments

Trading contracts for differences and forex markets typically do not involve paying commissions. Instead, traders only incur the spread, which is the difference between the buying and selling prices. Occasionally, there might be additional costs beyond commissions.

4. High Levels of Liquidity in Both Markets

Both CFDs and forex markets exhibit robust liquidity levels. This implies that you can execute your orders promptly at your desired price and enjoy the flexibility to enter or exit any position as needed.

Differences Between CFDs and Forex

1. Choice of Trading Instruments

When it comes to trading instruments, CFDs offer a broader spectrum, encompassing not just forex but a plethora of other assets. In forex markets, your options are limited to currency pairs. Major forex brokers typically grant access to eight primary currency pairs along with minor currencies. These include pairs like GBP/USD, AUD/USD, EUR/USD, and others. On the other hand, CFD trading opens up opportunities across various markets such as commodities, stocks, indices, ETFs, and bonds, providing a more extensive range of options.

2. Cost of Trading

Both CFDs and forex trading involve spreads, yet CFD traders may encounter additional fees depending on market conditions and broker policies. For instance, holding fees are common in CFD trading and applicable to positions held overnight. Moreover, trading Share CFDs may incur commissions as part of transaction costs.

3. Market Forces

Forex markets are influenced by economic factors and global events, including geopolitical shifts, labour market fluctuations, and alterations in monetary policies. Conversely, the CFD market is driven largely by supply and demand dynamics, alongside shifts in specific business sectors. For example, the demand for cryptocurrency CFDs is contingent upon factors like coin supply, affecting the market accordingly.

4. Size of Traded Contracts

In forex trading, standard lot sizes are fixed at 100,000 units for all currency pairs, although brokers often offer leverage to trade smaller lots such as mini (10,000), micro (1,000), and nano (100) lots. Conversely, CFD contract sizes vary across markets. For instance, shares typically equate to one share per contract, while metals are traded in units like 100 ounces, meaning one CFD contract represents 100 ounces of the metal being traded.

5. Trading Hours

Forex markets operate 24 hours a day, Monday through Friday, providing flexibility for traders globally to make decisions at various times. However, trading for other CFDs, except forex, extends into weekends. Nonetheless, certain markets may have restricted trading hours.

CFD vs. Forex — Which One is Right for You?

CFDs are tradable products within the forex markets, offering the potential for profit alongside considerable risk and complexity. The decision between the two should reflect your individual goals, preferences, and expectations, as well as your trading proficiency, financial resources, and risk appetite. It’s crucial to align your choice with your unique circumstances to optimize your trading experience.