Beginner Trader Guide – CFDs vs Traditional Forex

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The trading industry can be very confusing, especially for people who do not have a background in finance. It takes hard work and dedication to get accommodated with all of its intricacies. Add to that the fact that nowadays, they are three school of trading that you need to know about: Forex, CFD (short for Contract for Difference) and Binary Options.

These three options attract most of the attention, simply because they are the easiest to use and understand. But deciding which one is best suited to your trading style is a whole different beast. For this purpose, we have decided to dedicate a full article on their advantages and disadvantages.

Similarities Between CFD’s and Forex

Let us start with the similarities between CFD’s and Forex, as there are a lot of them. The first and most obvious similarity between them is that both are very close in terms of the trade execution process.

Traders can enter or exit the market whether it is rising and falling, and the trades are executed on the same platform, with similar looking charts and pricing methodologies. In both cases, trades are done through an automated, over the counter market connected to a network of banks and other financial institutions. Yet another similarity between these two is that the only fee that the brokers charge is the spread, unlike other types of trading that have commissions and other finance fees attached to them.

But the biggest similarity between these two types of trading is the fact that traders do not own the underlying asset in the traditional sense of the word. For instance, when a trader purchases a USD/CAD currency pair, they are not actually paying money for it, they are speculating on the exchange rate – meaning if the price will go up or down based on previous trends.

How Forex and CFDs Differ

The main difference between CFDs and forex trading  is of a contractual nature. CFD trading is focused on different markets that deal with energy, metals and indices. Forex, as you might already know, deals solely with currency trading. CFD trading offers the option of choosing between different contracts that vary in terms of currency type and increment value. Forex trading, on the other hand, is all about trading one currency against another, adopting short or long positions depending on the realities of the market.

Last but not least, a vital difference between these two is the factors that influence their respective markets. While forex is influenced by global events (whether political, economic, inflation, interest rates, unemployment), CFD trading is shaped by pure economic factors, such as supply and demand and general trends in the business sectors.

Now that we have covered the similarities and differences between these two very different markets, it is time to switch to their advantages and disadvantages. Hopefully, this will help you decide which trading type is more suited to your personality and experience.

Advantages and Disadvantages of the Forex Trading Market

Forex is beloved by many traders who are seeking a viable alternative to the stock market, and for a good reason, too. Here are a few of the advantages that the forex market boasts:

  • Its decentralized nature. The fact that there is no central regulator or third party involved means that traders have great strategical freedom.
  • Low costs. Fees and commissions are quite rare, as brokers make profit out of the spread.
  • Very lenient towards a wide variety of trading strategies. No matter what methodology you adopt, you are very likely to find plenty of opportunities if you play your cards right.
  • A wide variety of currency pairs to choose from. The forex market has a lot of shortcomings, but nobody can blame it for a lack of options. The enormous variety of currencies is a great opportunity for traders to experiment and find their niche.

As for the disadvantages of the forex market:

  • Steep learning curve. Compared to other trading markets, there is a lot more to learn. It takes a lot of discipline and self-control to reach a decent level.
  • High leverages and risks. The high leverage that brokers offer comes with tremendous risk, so forex traders have to focus on risk and money management.

Advantages and Disadvantages of the CFD Market

While the forex market is based on speculating on the currencies, CFD trading is focused on speculating on the value of a particular asset over a predetermined period of time. This comes with both advantages and disadvantages, as you will soon find out. Let us start with the advantages:

  • The specifications on various trading instruments are straightforward and easy to understand, meaning that CFDs do not have as steep a learning curve as the forex market.
  • Low transactions costs, as brokers charge very low fees compared to the stock market, for example.
  • No expiration date for CFDs.
  • There are no limits on contract sizes, as people can trade as long as they stay within their financial limits.
  • Automatic stop loss features – most brokers guarantee the activation of the stop loss feature.

As for the disadvantages of CFD trading:

  • Fixed leverage levels that can’t be worked around. This means that you have to build your strategy with a set leverage in mind.
  • Very high risk in terms of margins, even if one is not required to pay the full value of the share.
  • Brokers can close positions when the collateral becomes insufficient to cover the losses.

Conclusion

While they both boast tons of similarities, forex and CFD trading are two wholly separate entities that should be treated as such. Whether one is better than the other can’t be stated objectively, so it all comes down to each trader deciding which trading type suits them best. Hopefully, the points highlighted in this article will make your choice easier. Good luck!