Contracts for Difference (CFDs) and forex are two of the most popular types of trading for investors globally. With some striking similarities and fundamental differences, many traders struggle to choose which one suits them better.
Both forex and CFDs have their pros and cons, and there’s no single right answer. We take a closer look at what both involve to help you pick the investment that’s right for you.
What Are Forex and CFDs?
Both forex and CFDs are types of trading where you never buy a physical commodity. Instead, the trade is based on what you think the price will be. No underlying assets are ever owned, unlike stocks and shares.
Forex is focused entirely on the foreign exchange market and measures the value of currencies against each other. Each position is measured as a pair, with one currency’s performance tracked against another.
There is no market larger than forex, with trillions of dollars traded daily around the world. There are choices when trading forex currencies, with approximately 120 different currencies available to traders. The majority of the transactions centre on USD (US dollar), GBP (sterling), CAD (Canadian dollar), AUD (Australian dollar), JPY (Japanese yen), EUR (the euro), CYN (Chinese yuan) and CHF (Swiss franc).
CFDs operate on a very similar principle to forex, allowing traders to speculate on price movement in the future. However, unlike forex, which focuses solely on foreign exchange rates, CFDs provide access to an enormous range of different markets. There are more than 12000 possible trades for CFDs, with everything from oil and metals right through to indices and shares available to speculate on.
What Are the Similarities?
There are many similarities between forex and CFDs, namely:
- You will not own the underlying asset
- You can go long or short
- The use similar platforms
- They use margin and leverage
- It is high risk
What Are the Differences?
There are more similarities than differences between forex and CFDs, which is why there’s such an overlap in trading. Nevertheless, it’s essential to appreciate that there are fundamental differences that could influence what you choose to trade:
- CFDs offer a wider choice of markets
- Forex and CFDs respond to different factors; the latter is more sensitive to supply and demand of the underlying asset
- CFDs offer greater flexibility over trade size
- Forex is much larger and more liquid
Which One to Choose?
Choosing between CFDs and forex can be difficult, and some traders choose to enter both markets. It’s also possible to opt for a hybrid approach, using CFDs to speculate on forex.
Your attitude to risk and your personal goals can help determine the best type of trading to meet your needs. For example, forex is particularly volatile but has the potential to deliver very healthy returns.
Your knowledge and expertise should also be taken into account. Forex tends to respond to world affairs and political events; the weight of each depends on the currencies you’re trading. In contrast, CFDs are more sensitive to the underlying market that you’re speculating on. The supply and demand of the asset and the sector’s overall performance are more likely to influence the price.
Your background, interests and know-how, combined with your risk appetite, may well naturally lead you to either one or the other, but both have real merit.