Probably, every trader has faced the abbreviation CFD. But if you ask what this means, in most cases, the answer is: "it's something similar to Forex, only for stocks." And yes, in general, this definition is close to the truth, but there are some nuances that we would like to share with you.
But first, what are Forex and CFD themselves?
What is Forex
Forex is an international financial market founded in 1976. Forex trading involves central banks of different countries, global companies, commercial banks, and various traders which perform a currency exchange.
In general, trading is the process of buying and selling currencies to make a profit. The price of one currency is linked to another, so transactions are always made with two currencies simultaneously. Your profit (or loss) depends on the change in the currency price difference.
What is CFD Trading
CFD (Contract For Difference) is a kind of transaction between a trader and a broker. A CFD can be traded on other products different from the Forex currency pairs, such as indices, energies, and metals. It provides one party to pay another party a difference in the settlement price between the opening and closing trade. If the difference is positive, the broker pays the trader. And vice versa – in case of negative difference, the trader pays the broker.
CFDs help to trade many assets and securities, including exchange-traded funds. Traders also use these products to speculate on the price moves in commodity futures contracts such Although CFDs allow investors to trade the futures' price movements, they are not futures contracts by themselves.
Similarities Between CFD and Forex
CFD trading and Forex have many points of convergence. First of all, they trade over the counter (OTC). It means that they both have no physical location or central exchange and are run entirely electronically within a bank network.
Second, they trade through the same platforms with similar looking charts and pricing methods. CFD trading and Forex also carry related transaction costs. And besides, traders can easily access both rising and falling markets both on Forex and CFD.
One more thing that unites CFD and Forex is that the trader never becomes an owner of the underlying security being traded. For example, if you were trading the GBP/USD, you do not own the British pounds, but speculate on whether the pounds will rise or fall, relative to the US dollar. The same happens with CFD: if you were trading a commodity such as oil, it doesn't mean that you have a barrel of oil.
Differences Between CFD and Forex
There are two main differences between CFD trading and Forex. The first one is that Forex is limited to trading only currency pairs. However, CFD trading is much more flexible and can offer more diverse types of contracts.
The next difference is the crucial price determinants. Specific factors influence prices on CFD contracts, such as demand for a commodity or trend changes, associated with business sectors. However, the reasons which change the price on Forex are more fundamental: massive employment shifts, global political changes, or macroeconomic events.
Summary
CFD and Forex have many similarities, but they also have key differences. It is vital to keep them in mind to succeed when including CFD and Forex into your trading strategy. However, it's a must to have a reliable and legitimate broker such as FBS, that, as Rick Astley sang, will "never gonna give you up" and "never gonna let you down."
