Online trading has become hugely popular. Even non-professional speculators, ordinary people, now have access to an activity capable of opening the doors to the much-coveted financial freedom. Of course, the path is not downhill, and it's no coincidence that problems, especially from a decision-making point of view, arise immediately. Among the choices that the aspiring trader must make, the type of trading stands out.
The possibilities in the field are truly numerous. Lately, one of the most interesting "challenges" is
between Forex Trading and CFD Trading. These two types are generally paired for their remunerative capabilities and the speculative charge they can offer. This article will provide all the useful elements for the trader to make an effective choice, given that a universally better choice than another does not exist, but everything depends on personal characteristics and trading style.
Forex Trading and CFD Trading: two straightforward definitions
Before accurately describing the two activities and listing the differences (many) and common points (few), it's good to provide two brief but exhaustive definitions, capable of providing some context.
Forex Trading is the activity that allows you to invest in the currency market. Currencies are considered like any asset, such as a commodity or a stock. Therefore, the mechanism is that of surplus: buy low and sell high.
CFD Trading, on the other hand, is the activity that allows you to invest in so-called Contracts For Difference (hence the acronym). These are true contracts that bind the actors involved to execute the transaction of a given asset at a given expiration and at a given price.
Forex and CFDs: the only element in common
From these simple definitions, it's clear how different the two activities are. Yet they have one thing in common, besides being online trading activities:
they are both OTC. This is an acronym for Over The Counter and indicates a very important characteristic: not belonging to an officially regulated market.
This doesn't mean they have no rules, quite the contrary (the licensing mechanism requires brokers to meet certain quality standards), but rather that negotiations enjoy a wider margin of discretion. So, for various reasons and with consequences that can benefit traders, prices don't necessarily and faithfully reflect real market prices.
The differences between Forex Trading and CFD Trading
Below is a list – with attached descriptions – of the major differences between Forex Trading and CFD Trading.
Type of asset. Those who trade in Forex own the assets. If you open a long position on the euro-dollar, it means you are buying euros and selling dollars. Above all, it means that you are
actually buying euros and equally actually paying for them in dollars. Forex Trading, therefore, involves real ownership of assets. A radically different discourse if we talk about CFDs. Contracts for Difference do not presuppose ownership of an asset but are simply based on the value of assets. These, therefore, are present as underlyings. Obviously, returning to Forex, real ownership does not involve full operation, thus the immediate use of the asset. This can only be accessed after withdrawal, which is anything but immediate and directly regulated by
brokers.
Variety of assets. An immediate corollary of the first difference concerns the question of variety. If CFDs work with underlyings, it is evident that any type of asset can be included among these. For this reason, those who trade with CFDs enjoy a practically boundless variety: commodities, precious metals, stocks, bonds, even currencies. On the other hand, those who trade with currencies can obviously only trade in currencies. The most important consequence of all this is that diversifying is much simpler in the CFD market than in Forex. In Forex, if the trader wants to diversify, they still cannot move from the perimeter of currencies, so they are forced to change, at most, the pair, and this means knowing the correlations between pairs (a very thorny and difficult subject to master). Those who invest in CFDs only need to change the underlying, and in this way, they will practically change the market.
Costs. This is a very important point since the expenses charged to traders can significantly erode profits and, in the worst case, nullify the trading activity. Well, the business models from which the costs derive are radically different. Forex brokers in most cases (i.e., when they are Market Maker) do not apply any commission, but rather spreads. These can be defined as the difference, expressed in pips, between the market price and the price that the broker "proposes" to the trader. Spreads vary from broker to broker, as is fair (this mechanism favors competitive dynamics) and from pair to pair, but in general, they are already known to the trader even before they start investing. CFD brokers, on the other hand, use a very different approach. In short, they reserve wide margins of discretion: some assume the Forex model, i.e., they only impose spreads. Others impose percentage commissions on the investment volume. Still others impose both commissions and spreads. In short, the situation is far from homogeneous and must be evaluated by the trader on a case-by-case basis.
Analysis approaches. This chapter is also a source of division. In general, doing fundamental analysis for Forex is simpler, although it still remains an extremely difficult subject. This is because, basically, it's always a matter of investing in the same type of asset, and sooner or later, specific skills and competencies are developed. Doing fundamental analysis for CFDs is a different story: it's necessary to change the approach as soon as the asset is changed, in a vicious-virtuous circle that requires the development of ever new skills and competencies. If the underlying is represented by stocks, the discourse changes again: it's necessary to study not so much the market movers, but rather the documents of the issuing company, i.e., the income statement, the balance sheet, the cash movements, the financial statement. A whole different story.
Training. Finally, the training chapter also plays a leading role. The truth is as follows: Forex is a more "mass" activity than CFD trading. This implies that brokers have spent a lot of resources to create training content. They simply have a larger audience. CFD brokers, aware that this activity is still, at least partially, elitist have not spent many resources in this regard. The consequence is that it is much simpler, starting from scratch, to become a Forex trader than to become a CFD trader.
