When it comes to choosing what to trade, there are all kinds of options available out there. From stocks and shares to rental properties, there are plenty of vehicles that you can use to invest and grow your money. Two of the most popular modern assets, though, are foreign exchange currency pairs and CFDs. What exactly are these assets, and what are the advantages – and, of course, the disadvantages – of each?
What are these assets?
First off, it’s important to understand what these assets actually are and how they work. To most people, foreign currency is bought and sold primarily in order to enable spending when traveling abroad, or perhaps to finance a particular purchase such as a foreign property. However, the high level of demand and change in foreign currency exchange rates means that speculators who are out to make a profit will bet on whether or not a certain pair of two currencies will rise or fall. All speculative forex trading is done in this innovative “pair” format, so it’s important to remember that you’ll always have to bet on the rise of one against the potential fall of another.
A contract for difference, or CFD, meanwhile, is a derivative product that does not actually convey any ownership of the underlying asset. This article will go on to explain exactly what CFDs are and why they are so popular among many investors. Confusingly, a tradeable instrument can be both a forex pair and a CFD: if you decide not to actually buy the foreign currencies themselves and instead buy their CFD versions for the reasons outlined below, then you’ll essentially be trading the forex markets without actually owning any forex!
The power of marginal trading
As is the case with CFDs, if you choose to trade forex, then you’ll be able to do so in a way that’s known as “over the counter”. This means that you won’t actually have to buy the currency itself: instead, you’ll enter into a contract with a financial institution, and this will then be used as your stake in the currency. However, unlike CFDs, you won’t have quite as many options when it comes to amplifying your coverage. CFDs are traded “on the margins”, which means that you can amplify your potential gains – as well as your potential losses – by using what is known as “leverage”.
Costs and fees
In many cases, the fees for trading forex and the fees for trading CFDs are largely the same – so there’s no need to worry too much about basing your decision about what to trade on this. To some extent, this will depend on the broker you choose, which means that reading this table of forex and CFD brokers is a good idea. It’s also the case that many brokers will charge a fee on by calculating a proportion of the spread (which is the difference between the price you buy the asset for and the price you sell it for), so there may be some mathematical working out for you to do.
This is perhaps the most obvious difference between the two, but it’s an important one nonetheless. Trading forex means that you’ll have to become an expert in that particular market: you’ll need to become conversant in the central banking sphere, for example, and learn to identify quite niche market triggers such as interest rate changes or political events.
The advantage of choosing the CFD route is that you’ll be able to specialize in one of many different market areas, or chop and change between them as you see fit. You may choose to trade markets such as commodities, say, or stocks in major firms such as Apple or Facebook. Or you may choose to trade all of them, or interchange! If this sort of flexibility and choice is appealing to you, then avoiding heading down the forex-only route is probably a smart decision.
When it comes to these markets, there’s no right or wrong answer. Choosing between CFDs and forex pairs will come down to a host of factors that are personal to you: from the level of market choice you require to whether or not you feel comfortable taking advantage of leverage options, there are plenty of differences to take into account. And with some factors such as costs often much the same regardless of the option you go for, there are also plenty of similarities to bear in mind.
Disclaimer: This content does not necessarily represent the views of IWB.