The difference between Forex trading and CFD trading
The forex trading market
The forex market, also known as FX, is where currencies are being exchanged and traded. Needless to say, this is one of the largest and most explosive trading markets you can come across.
Currencies shape the world in a rhythm most of us can’t even keep up with. Professional traders are being caught off guard regularly, which goes to show how feral this sector has become over the years.
– Affordable investment requirements – One of the main benefits of trading in the forex market is that the costs of operating within this sector are quite low. We include here any type of commissions, brokerage fees, when applied, which is very rare, along with any other extra payment that may come along.
– The lack of a central regulator – The forex market is generally free, with no third-party entities interfering with the trader’s activity whatsoever. The fact that it is decentralized is a major plus, especially when you think of the fact that there are no crushing “surprises” to fear. No mammoth corporation washing its laundry in the public, causing prices to fluctuate dramatically and burning through the traders like an incandescent flare.
– Malleable and trader-friendly – No matter the trading strategy you adopt or the trading profile that defines you as a general rule, the forex market is perfect to suit you in every way. Whether you are a short-term or a long-term trader, you are sure to find plenty of opportunities to play with. In my book, this is one major plus, especially for beginners and intermediates.
– Delivers the highest liquidities with minimum of impact – This is where the main difference between forex and CFD stands out. The forex markets are some of the largest and most active you can find. What this means is that it is able to deliver higher liquidities without impacting on the price charts. At least not as much as to allow sudden devastating price fluctuations or price deviations that could install chaos in the market. We are talking about steady patterns, regardless of the liquidities being moved. Priceless, I say.
– Transparent tendencies – One of the main assets is that (and this is true primarily for major currencies) currencies often display major price variations. For a professional and experienced trader, this is virtually a gold mine. One right bet, placed in the right direction and at the right time can deliver an immense chunk of income.
– Variety and increased accessibility – You have more than two dozen major currency pairs, allowing you to apply your system in a wide variety of circumstances. In addition to that, you have probably the largest base of technical indicators, analysis tools and extensive guides on the trading industry to assist you. It doesn’t matter whether you are a beginner or veteran, the degree of control you get is almost exhaustive.
– Its crippling volatility – You may notice that we have noted volatility as being a plus, in terms of price swings. Well, here it goes, this time working against you. Massive price swings are not always easily detectable in time. If they catch you on the wrong foot, the financial blow you might withstand could maim you for good.
This is that much more dangerous when you come to think of the many factors that influence the forex market, of which you have no control upon. We are talking about global economic, social and political events that could shift the balance in the blink of an eye.
– A lot of self-learning is required – Compared to other trading markets, here you are pretty much on your own. You need to have a lot of initiative and become self-taught if you want to stand with the best. This means you need discipline, control and a lot of hard-work.
– With high leverage, comes higher risks – You probably know how high leverage works. The best part about it is that the gains can be significantly boosted. The downside is that the losses can follow the exact same path in terms of quantity. And the problem with forex trading is that it only deals with high leverage. Risky for a beginner who lacks a solid grasp of the concept and the mechanism, but highly rewarding for an experienced trader.
If we were to draw the line, I would say forex trading is mostly suited for those who already have some basic knowledge about how the trading market operates. Although I should say mostly suited for those that are already experienced. Because simply knowing a lot of stuff doesn’t make you a good trader.
Is it risky? Of course it is. Is it worth it? That, my friend, is entirely up to you. But let’s move on to the next one.
The CFD trading market
CFD trading vs. Forex trading can be summed up in terms of general profile. While the forex market is all about speculating on the currencies, the Contract For Difference is all about speculating on the value of a given asset over time. For an easier understanding, the CFD represents the contractual agreement between a buyer and a seller that stipulates the terms under which both the buyer and the seller operate in relation to an asset’s value.
If the difference between the asset’s value at the time the contract was open and the current one is positive, then the seller has to pay the buyer the difference. If it is negative, the buyer needs to pay the difference to the seller. Pretty straightforward, right?
– The transaction costs are low – And by “low” we mean a lot lower than other options. Like shares, for instance, where the brokers will usually charge you a lot. Depending on your CFD providers, you could get really cheap deals, compared to the alternatives.
– Easier to understand and use – This is why most traders prefer starting with CFDs before moving on with more demanding markets, like forex. For instance, if you already know how share trading works, you know how CFD trading works.
– No expiry date – You can close a CFD manually, at your own accord. And the fact that you are not time restricted by the market is a priceless advantage, because it gives you more control over your trade.
– Higher control over your contingent orders – It is pretty easy. If you want to go for more complex orders, you can do that to a higher degree than with the rest of the other options. Like, for instance: As soon as the market hits this threshold, buy X units after 10 AM and Y units after 5 PM.
– The automatic Stop Loss feature – As soon as the stock price tears through your stop loss, you have the option (with some brokers) to activate the guaranteed stop loss feature, working for you, independent of your control
– The option to go global with one account – This is a feature that isn’t available with indices, commodities, treasuries and many others. In this context, you can see how the option of accessing a multitude of international options has the potential of opening a myriad of profitable opportunities on the long run.
– You are not limited by strict contract sizes – You can trade as many shares as you wish, as long as you can keep up with your funds.
– Trade on margins – As you may already know CFDs work on leverage, meaning that you get the chance of using your capital more efficiently as a result. You are no longer required to buy the shares at their full value, but only required to pay a fraction (usually between 5 to 10%, depending on the type of shares and the broker).
– The leverage could backfire – However, it is only natural. If you know how leverage works, you know that it can give you as much as it can take away. This is where rock-solid financial strategies come in play, able to minimize the losses and maximize the profits.
– Overall riskier than trading shares, for instance – Sure, you are not required to pay the full value of a share. And although that may seem seductive, this doesn’t mean you can’t lose your margin.
– The risk of losing control – The main difference between forex trading vs CFD is that CFDs are extremely easy to play with. Combine that with the low capital requirements and you can see how the situation can quickly grow out of proportions. In this context, over-trading and not knowing when to cut your losses are the real threats.
– The margin call – The margin call is a pretentious name for the situation when your potential losses outweigh your current account funds. It works pretty much as a collateral. The moment the collateral becomes insufficient, your position will be viewed as no longer reliable and the broker can forcibly close it.
– The leverage levels are fixed – The broker will usually set a specific margin level you simply cannot work your way around. All you can do is to put strategies in place to help you cope with any potential risks, as you cannot modify the already installed margins. What’s even more, some brokers find fit to increase those margins in the middle of the trade and force you to up your stakes if you want to avoid early closure.
If I were to analyze CFDs, I would say they are overall friendlier with your everyday occasional trader, especially because of the higher degree of control you get. That being said, the disadvantages are quite a few. But, and here is where it gets interesting, most of them are circumstantial. Meaning that, in many cases, they depend strictly on the policies of the brokers you work with.
Other disadvantages, like the danger of over-trading, depend on your deliberate actions. So, as far as I can see it, the dangers are not insurmountable by any means.
CFD trading vs. Forex trading – A parallel analysis
Having plenty of information to base our verdict upon is usually easier said than done. This is because the theory is always easier to analyze and draw conclusions upon than practice. In reality, everything is volatile and unpredictability plays a major role in determining a specific outcome.
But when talking about CFD and forex trading, I believe we have sufficient solid data to draw a conclusion.
In my opinion, I believe both markets are accessible for every trader, pretty much regardless of his experience or insight capabilities. However, and I want to stress the word “however”, as an unexperienced trader, I would recommend the CFD market. It is more trader-friendly, it comes with less risks (referring to those that are out of your control) and the winnings are generally steadier, if you play it safe.
Compared to that, forex markets are more volatile and dangerous. The bright side is that the possibility of multiplying your investment considerably is a lot higher than with CFDs. Which makes this option perfect for experienced and talented traders, looking for real challenges and real outcomes.
Learn from my experience
I have played with both forex and CFD trading. I know pretty much everything there is to know about risks, trends and the importance to work on tested, efficient strategies.
If you are determined to make your way through the trading jungle, be it either forex or CFD trading, here is what I would advise you:
Regarding forex trading
1. Learn as much as you can. This is an unforgiving sector that will build on the tiniest mistakes and quickly snowball out of control, with potentially gruesome consequences. Know what to expect, learn strategies, learn how to control and manipulate your finances and never go over the top.
2. Stay up-to-date. Keep a close eye on the news. Read everything you can related to the field you are activating in. Major global political or financial shifts can impact the forex market all over the world. Eliminate all surprises.
3. Know when to cut your losses. This basically translates by “learn emotional management”. The trading industry is about using math and probability. Emotions have nothing to do with it. Adopt a mathematical mindset and learn when to draw the line. Cutting your losses is crucial in giving yourself second chances.
Regarding CFD trading
1. Choose your broker with care. Check your future broker’s policies to eliminate any surprises. This is one of the best advices I can give you, regardless of the trading sector you go for.
2. Always pay attention to the margin. If you lose sight of the margin, you might end up hitting the margin call, forcing your broker to close your position. This could prove disastrous in some cases. And since this is something you can fully control, act like it.
3. Do not over-trade. This is a real risk, because, as you already know, the difference between forex and CFD is that CFDs tend to seduce you with their simplicity. Just because you win now doesn’t mean you will win the next move. And if the next move is bigger than your last 3 moves combined…
As you can see, this article is actually less “CFD vs Forex” and more “proficiency vs superficiality”. This should tell you everything you need to know about the trading business.