The Difference Between Forex And CFDs
Foreign currency exchange is officially the oldest form of trading in the world, with a history dating back for many thousands of years. In its newest manifestation, which you will most likely know only as Forex, it is also the most popular, with trades totalling more than $5 trillion happening every working day.
CFDs (Contracts For Difference) are a relatively new market by comparison, with a history spanning just about 20 years, but since 2003, they really started to make their mark and are now increasingly popular with traders on all levels.
There are some areas of these two markets which overlap and a few similarities, but on the whole, they are two very different opportunities. Where Forex is explicitly concerned with trading in currency pairs, CFDs also include currency as the medium, but there is a whole host of other options too.
In this guide, you will learn:
- More about potential payouts and losses
- The trading costs you could incur online
- Whether Forex or CFDs are best for you
Trading Payouts And Losses
Forex is available via specific worldwide exchanges for 24 hours per day (covered by three sessions) on each weekday. Because currency is highly sensitive to world political and economic events, the Forex market is not stable and completing a trade at just the right moment can lead to a massive payout, especially if high leverage is used to increase investment potential.
Equally, the market can change in seconds and what appeared to be a certainty can turn completely around and cause a life-changing loss. There are tools to minimise the impact of transactions going awry and it is essential for anyone trading in Forex to be aware of the implications of not doing so.
CFD trading does not require a specific marketplace. You are taking a contract which reflects your view of a given economic scenario. CFDs can be related to currencies but also stocks, shares, commodities and cryptocurrencies. As with Forex, leverage can be used to invest above your margin and theoretically receive a higher payout for a lesser investment.
Unfortunately, when CFDs first became available to retail traders, they were often mis-sold as ‘get rich quick’ investments which many unwise investors fell foul of by using too much leverage, with many losing lost vast sums overnight.
Forex is a long-established, tax-free form of trading.
The Costs of Each Method
Forex and CFDs both have expenses in terms of broker or exchange fees and commissions, which must be taken into account when you are calculating their potential for investment.
While Forex is tax-free, the actual cost of each trade is not known until it has reached completion. Broker fees, transaction costs, commissions and wider spreads can soon add up and take away a surprising amount from your (expected) overall profit.
With CFDs, there are fewer costs because it is a ‘difference’ that you are taking the contract on, rather than any specific value during the life of the trade. Your CFD remains unaffected by any changes in value to the underlying asset; it is the result at the end that is all-important.
However, you should also be aware that CFDs are subject Capital Gains Tax (although they are exempt from Stamp Duty) as well as predicted fees and commissions.
Which Trading Type Suits You
For both of these exciting trading opportunities, there are advantages and disadvantages. It is possible to use both, but if you are less experienced, it may be better to confine your activities to one or the other initially.
The modern Forex market is relatively well defined in terms of trading platforms, ease of entry and tools to assist with analysis and risk management. There is also a vast amount of information available in all types of media (from books to YouTube videos) which can help with the intricacies of formatting a Forex strategy.
The world of CFDs has less readily-available sources of information and many more options than Forex, so it is necessary for you to work harder to obtain indisputable facts and to find suitable platforms from which to trade. Many advertisers will claim this is not the case, but be wary!
The Final Pros And Cons
Both Forex and CFDs are popular options for traders on many levels and have proven valuable tools when used to their best advantage. In terms of potential gains, risks and trading costs there is little to choose between these two markets.
However, neither are particularly straightforward options and it is essential to understand the underlying assets fully, to be aware of how much you could potentially lose and to have a robust risk-management strategy in place before investing.
If you need to choose between them rather than adding both to your trading strategy, then you should be aware that CFDs may require more time for research due to the eclectic mix of options on offer and potential pitfalls.
Forex Pros: Forex is a long-established, tax-free form of trading. There is a relatively high learning curve (when including risk-management techniques) but also the potential for virtually unlimited payouts.
Forex Cons: Each transaction has hidden end-of-trade costs, whether it is good or bad. Forex is an unpredictable/volatile market and losses are possible without fallback options in place.
CFD Pros: There is a tremendous amount of choice for potential trades. Usually, spread fees and broker commissions are lower. There is often no ‘per trade’ cost levied by the majority of brokers.
CFD Cons: Payout potential is less and available leverage is lower because there is no advantage or disadvantage in asset price changes. Without adequate research, there is a real risk of falling into the hands of a less-than-ideal broker and overpaying fees as well as incurring losses.
Contributing to the website since 2012 we are one of many consultancy projects Samuel works on. With 38 years of experience in finance, insurance and foreign exchange his combined knowledge makes him an effective operator. Learn more.