What are CFDs in forex trading?
So you’ve come across these terms and are a little confused as to what they actually mean, and want to know if they are the same thing. In very simple terms, Forex is a subset of Contracts for Difference (CFDs), where the underlying asset price is only ever currency exchange. Contracts for Difference are speculating on the price change on a much wider array of underlying assets such as commodities, market indexes and energy prices. So to answer what are CFDs in forex trading, one might say they are the overarching superset of financial instruments that offer leverage and exposure to the price change of any of a number of financial assets and markets.
What is CFD in Forex?
CFD (Contracts for Difference) are an overarching superset of Forex with more underlying assets available. The price change of commodities and cryptocurrency can be speculated on with CFDs, while Forex only relates to currency pairs. Both involve leverage in nearly all cases.
Forex and CFDs are leveraged products
To go into more depth, let’s put some examples behind these words. Forex is leveraged speculation on the price change in foreign currency pairs such as EURAUD (purchasing Euros and selling Australian Dollars). In forex you would not actually buy Euros with Australian dollars like you might in foreign currency transfer, you actually are taking a position on the exchange rate of these two currencies. With Forex, like CFDs it’s almost certain that you will be taking leverage on this position (see my article here on the unusual case where you take out a CFD without leverage). To do this you would put an amount of money on margin and set your leverage to a rate you are comfortable with. (For an example of a broker you can do this with, check out my article on Plus500 Features).
Contracts for Difference basically operate with the same mechanics but are on different underlying assets. You may be knowledgeable of the markets of cryptocurrency, energy prices, commodity prices, share indexes or other and these are all commonly offered markets on which to base a CFD trade. Contracts for Difference, like Forex are over-the-counter derivatives, meaning that the market is normally offered by the broker or other market makers themselves. Exchange traded CFDs are available in Australia but are not as commonly utilised by traders and speculators.
So it could be said that CFDs and Forex are ‘same-same but different’ to quote one of my favourite Thai sayings. Both have wide ranging implications for risk and reward and trading them is definitely not for the faint-hearted or those that aren’t confident in their own trading ability. Most CFD and Forex providers offer Demo accounts, it’s well worth checking one of these out to become familiar with the trading platforms and markets available. I also look at CFDs vs Forex in a bit more depth in this article.