Forex vs CFD

The brokerage industry is characterised by such a stiff competition that Forex brokers try to do everything to attract new customers. Merely attracting new customers is not enough to survive in this business, though; retaining the current traders is key for a Forex brokerage house. However, this is not an easy task, as active traders are difficult to find.

Nevertheless, conditions are still in favour of more and more people coming and joining the Forex market. This is because people in all corners of the world have access to the Internet, and that number is increasing by the day. A Forex broker needs to split its efforts in two directions: on the one hand, it needs to attract new clients, while on the other hand, it needs to keep the active ones trading. This is a difficult task to accomplish. As a business that runs in pretty much the same way for every brokerage house, the Forex industry offers little chance for brokers to differentiate themselves from one another. If you go and check a list of brokers and their offerings, you’ll find out that they are all pretty similar. This is not good for any business, as customers tend not to be loyal if there is a similar offer just around the corner. To avoid that, Forex brokers desperately try to offer something new every time.

What is CFD?

One way to differentiate a Forex business from another one is to try to keep up with technological changes. This is a field that changes by the day as more and more things are developed, and therefore a whole department is needed for this task. Another way is to offer other financial products that can be traded on the same trading account. Such a product is a Contract for Difference (CFD). A CFD can be traded on products other than the Forex currency pairs, such  as individual stock companies. As the name suggests, a CFD is a financial product based on the difference between the entry and the exit price. If this difference is positive at the time the trade is closed, a profit is made. If not, the trading account takes a loss. The trading principle is the same as when trading a currency pair, except that the underlying financial product is different.

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Advantages of Trading CFDs

forex vs cfdThere are many advantages of trading the CFD market, and also many incentives. The most important one of them all is the fact that the CFD market gives access to a whole new world of opportunities besides the Forex market; and everything can be done on the same trading account! There’s no need to open a different trading account, as the CFD products are simply offered for trading in the same account. If the account is opened with a broker that has the MetaTrader platform in its offering, the thing to do is to go to the tab that shows all the currency pairs that are offered, and then simply right-click on any pair. Next, select the “Show All” tab. The result will be that all financial products offered by that Forex broker, CFDs included, will be listed, and in this way, the entire offering can be seen. In general, a CFD is based on a company’s stock price. This gives access to the stock market, a market that cannot otherwise be traded with a regular Forex account.

To trade the stock market, a trader needs to open a trading account designed especially for this. This is both time-consuming and costly, in the sense that resources are divided. In contrast, the same information needed to trade the Forex market can be used for trading CFDs, and that is fundamental information. To give you an example, imagine that the Federal Reserve of the United States raises the interest rates for the federal funds. Such a move is beneficial for the financial sector, and banks will be the first ones to see profitability increasing, and so buying a CFD on a bank stock price is the way to go. If the price of the stock is indeed moving to the upside, the CFD will return a profit, based on the difference between the buying price and the selling price. Of course, trading the stock market is not that straightforward, as other things intervene to influence the way stocks are moving. Things such as the earnings calendar, dividend dates, mergers and acquisitions, etc., all influence the price of any given stock, and this has nothing to do with the Forex market. However, having access to an entirely new market other than Forex allows traders to diversify their strategies and portfolios. This is the first step in a proper money management strategy designed to keep the value of a portfolio on the rise.

Disadvantages of Trading CFDs

The biggest disadvantage when trading a CFD is the margin needed for a trade. This is, by far, much bigger than the margin locked for any Forex trade. Brokers enjoy this immensely, as the lower the margin level in a trading account, the more business it means for them. Let me explain this in a few words! When opening a trade in a trading account, the margin for that trade is blocked. The more trades that are open, or the bigger the volume, the lower the free margin level will be. If positions are going against the trader, the available margin will become smaller and smaller, and the trader faces two choices: either to add more funds to the trading account (hence, in the future they will trade some more, so the Forex broker will benefit) or to close the current positions (closing the positions to free up margin in the trading account means the Forex broker will benefit, as new positions will be opened and commissions and fees will keep pouring in). As a result, trading CFDs is costly for the Forex trader, but represents a good business opportunity for the Forex broker. To put it bluntly, for the broker it is a win-win situation. Besides the margin thing, a CFD is a product that is riskier than trading a currency pair. This is a curious statement to make about the Forex market, a market considered to be extremely risky. Nevertheless, CFDs are riskier still. These products move based on the factors that influence the Forex market, plus some more, such as dividend dates, the earnings calendar, etc. Moreover, diversifying too much in a trading account has the effect of splitting the attention and focus in too many directions. This can result in the trading account incurring losses as the focus is split. To sum up, trading Forex and CFDs is similar, but the factors that move the two markets are not the same. Being able to combine the benefits of both markets is something that successful traders succeed in doing.

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