CFDs vs Forex: Differences and Similarities | Capital.com (2024)

Contracts for difference (CFDs) and foreign exchange (forex) are different in nature, yet there may be some overlaps in trading the two.

Read on as we compare and contrast CFD trading vs forex, and explore the intricacies of each.

Highlights

The main difference between forex and CFD trading is that CFDs are derivatives, meaning traders don’t own the actual asset, but rather something that derives its value from the asset. Forex is an actual asset itself.

In both cases, it is common to trade with leverage, in effect borrowing money in order to trade, which can magnify the potential for profits but also losses. In fact, traders often use CFDs (and other leveraged derivatives) to trade in the forex market.

With a CFD, you speculate on the price to rise or fall over a particular time period. If you open a long position and the asset’s price rises, you’ll profit by how much it has gone up, but if it falls, you’ll lose out. If you go short and the price drops, you could make money, but if it rises, you would lose.

Euro to US dollar (EUR/USD) forex trading chart

Past Performance is not a reliable indicator of future results.

The forex market is an asset class that concerns fiat currencies and how they could behave in relation to one another. Forex trading is the act of buying and selling different currencies in the hope that market fluctuations will make one currency rise against another.

In forex, one can trade currency pairs, buying and selling as the exchange rate changes. It is worth pointing out that this does not often happen in everyday retail trading. Price movements are often so small that, in order to see a reasonable profit, you would have to buy or sell a substantial amount of currency.

This is why a lot of traders use leveraged derivatives as it gives them the option to magnify their access, or exposure, to the market – this can provide greater profits but also greater losses. One can also trade currency exchange traded funds (ETFs) or use financial derivatives, such as CFDs.

Similarities and differences between CFD and forex trading

CFDs vs Forex: Five key similarities

There are several things that link contracts for difference and forex trading. These include:

• Short-term trading ability: Both CFDs and forex can be used to trade in the short term.

• Liquidity: Both potentially have high liquidity, allowing traders to get into and out of the markets relatively easily. However, with CFDs, if an underlying market is illiquid, then the CFD will also be relatively illiquid. Similarly, some rarer forex pairs will be less liquid than the larger ones, such as EUR/USD or GBP/USD.

• Long trading hours: CFD trading hours depend on the timeframe in which the underlying asset can be traded. Forex can be traded at any time from 5pm Sunday to 5pm Friday Eastern Standard Time (EST).

• Low transaction costs: Both assets have relatively low transaction costs compared to some other assets and instruments.

• Risk: CFD and forex trading involve a high degree of risk, including the possibility of losing more than your initial investment, in the case of CFD trading. It is important to carefully manage your risk when trading either. It is vital to do your own research, remember prices can go against your position, and to never trade with more money than you can afford to lose.

CFDs vs Forex: Five key differences

The main difference between trading CFDs and forex is that the first are instruments that derive their value from an underlying asset, rather than the asset itself. On the other hand, forex involves trading fiat currencies, although you can use CFDs to trade forex.

Other differences include:

• Range of assets: CFDs are available for a wide range of different assets, while forex only involves fiat currencies.

• Trading structure: CFDs are financial derivatives and involve entering into a contract with a broker. Meanwhile forex trading is more likely to take place directly between two parties, although, in the case of forex derivatives, a broker may be involved.

• Factors influencing market: Forex prices are often affected by economic decisions made by governments, as well as the shape of the market in the country or countries where the currencies in question are legal tender, while CFD prices are affected by supply and demand for the underlying asset, although if the underlying asset is forex, CFD prices will be affected by the same things as the forex markets.

• Price quotations and charges: CFDs are quoted in terms of the difference between the current price and the future price, with CFD brokers adding their charge – the spread – into the difference between the two prices. Forex prices are quoted in terms of the value of one currency relative to another, with no spread.

• Regulation: CFDs are often subject to stricter regulatory oversight compared to forex, with some countries, such as the US, Brazil and Belgium placing restrictions on CFD trading.

In conclusion

Both CFD and forex trading have their similarities and differences. CFDs are a leveraged derivative product, or instrument, that a trader can use to speculate on rising and falling prices in a range of financial markets. Forex, however, is a financial market in itself. CFDs offer exposure to a wider range of assets with leverage and forex focused solely on currency trading, although you can use leveraged derivatives such as CFDs to trade forex.

An important thing to remember is forex, CFDs and, for that matter, all forms of trading, carry a high degree of risk and it is important to manage this risk carefully. Ultimately, the choice between CFD and forex trading will depend on the trader's goals, risk tolerance, and investment strategies, meaning that getting your own answer to the CFDs vs forex question is, ultimately, up to you.

FAQs