CFD Forex Trading
CFD forex trading is an increasingly popular method of investing in currencies. Many traders have added forex CFDs to their portfolios. This article will explain what CFD forex trading is, how it works and how to get started. There will also be guidance on forex CFD trading strategies and how to choose the right broker and trading platform.
What Is CFD Forex Trading?
A contract for difference (CFD) is a contract between a buyer (trader) and a seller (broker) that stipulates that the difference between the current value of an asset and its value at the end of the contract will be paid to one of the parties at the expiry. CFDs allow investors to profit, or lose, from price movements without having to own the underlying asset.
How CFD Forex Trading Works
Essentially, CFD forex trading entails opening trades based on whether the value of one currency will rise or fall against another.
The investor can speculate on either upward or downward movement in the value of the currency. If they think the value of the base currency will rise, they will open a long position. If the value does increase, the net difference between the purchase and sale prices will be the net result of the trade (either profit or loss).
Similarly, the trader could believe the value will drop and open a short position. In this case, the profit or loss is the net result of the value between the initial price and the final value.
A good way to understand CFD forex trading is to look at an example, such as the GBP/USD forex pair. Consider that the ask price is 1.20720 and an investor believes the value of the pound (GBP) will rise against the US dollar. That investor purchases 1,000 pips of GBP.
Two weeks pass and the value of the GBP has risen as the investor predicted, the bid price is now 1.22220.
The trader is paid the difference between the initial ask price and the final bid price, multiplied by the size of the trade. That is 0.015 multiplied by 1000, which equals a £15 profit.
CFD Forex Trading Vs Spot Forex Trading
Forex trading can be conducted with or without CFDs, but what difference does it make?
In non-CFD (spot) forex trading, traders still speculate on the value of a currency rising or falling against its pair.
However, they then directly buy or sell the currency, depending on their position. This means the investor owns the currency itself and more money is required to buy the currency. Profit or loss is then finalised by directly selling the currency when the price has risen or fallen.
In CFD forex trading, you are only speculating on the value rising, without buying and owning the currency. CFD brokers usually require a much smaller margin (around 5%) and any profit or loss comes from the spread between the initial currency value and the final value of the currency.
Where You Can Trade Forex CFDs
CFD regulations vary in different countries. CFD trading, forex or not, is banned in the US and Brazil. However, many other major trading countries allow these instruments. Countries like the United Kingdom, Germany, Switzerland, Spain and Hong Kong all allow forex and CFD forex trading in over-the-counter (OTC) markets.
There are a few different trading strategies you can adopt when trading forex CFDs. We will run through four of the most popular below.
This is the practice of making short-term trades on the same day. Typically, the CFD forex trading position is held for anywhere from a couple of minutes to several hours before being sold, though it is not generally held overnight. The premise involves taking advantage of volatile forex pairs and requires high levels of concentration, you need to constantly monitor the market and be ready to make quick decisions.
This is similar to day trading, except that positions are held open for minutes at a time and closed as soon as it becomes profitable. Again, this involves constant monitoring of the market.
The strategy hopes to minimise risk by reducing the opportunity for a reversal and profits are made by the aggregation of many low-profit, high volume trades. Margin trading is often used to facilitate scalping, though you should be careful as one large loss can erode a significant portion of your progress.
Position traders don’t take short-term approaches like day traders and scalpers. Instead, a position trader will buy CFD contracts and hold them for a few days or weeks. This is a strategy that doesn’t require such constant monitoring of the market but it can need perseverance if there are market dips.
Swing trading is suitable in more volatile markets than position trading. The emphasis is on looking for strong price swings over one or several days. The strategy entails identifying short-term trends and waiting for signs of a reversal, trading against the trend once there are some. Swing trading may require that CFD forex positions be held overnight, incurring additional interest fees.
Pros Of CFD Forex Trading
- High leverage
- No shorting rules
- Low/no commission
- Instant order execution
- Trade both short and long positions
- No minimum day trading requirements
Cons Of CFD Forex Trading
- Not all countries allow CFD forex trading
- Quick execution makes it easy to overtrade
- Financing fees can be high when contracts are held for days/weeks
How To Start CFD Forex Trading
This step-by-step guide will help you get started trading forex CFDs:
Choose A Broker
The first thing to do is select the best CFD forex trading brokerage for you. Low spreads and financing fees are two basic things to look out for, along with trading platforms, asset ranges and customer service.
There are many brokers, both regulated and unregulated. Forex and CFD trading with Videforex, IG Group, Oanda or XTB are popular choices. Additionally, more options, like CFDs on forex, stocks, indices, oil and gold are available with XM.
Those investors looking for mobile trading may want to consider Trade Interceptor and xStation, both of which offer APK and iOS trading apps.
Select An Asset
Each forex pair comes with a different level of risk. Major pairs like USD/GBP are relatively stable and demonstrate strong liquidity. Exotic pairs such as GBP/HKD are more volatile and have more dramatic price movements, giving more potential for those that know what they are doing.
Open A Position
Once you have selected an asset, you can open a CFD forex trading position by taking out a contract. Be sure to check the leverage ratio and ensure you have the funds to cover any potential losses. Also, look at implementing stop loss and take profit orders to limit risk.
Monitor & Close Position
Keep an eye on the price and trends for the currency pair you have a position open on. Many platforms will have a mobile app for you to use on the go. Consider any fees when looking to leave the position open overnight. As soon as the price is right, close your position and finalise the trade.
This list of tips will boost your CFD forex trading skills:
- Stay Up To Date: Price movements can change rapidly and randomly. Make sure you are constantly monitoring the charts. Also, keep up with any news announcements, major stories can have a large impact on forex pairs.
- Stop Losses And Take Profit Orders: Don’t let your losses run wild, set a stop loss to automatically pull out and stop yourself burning funds if the market swings against you. Equally, ensure the trade closes if the value hits a certain point. You don’t want to miss out if you were asleep at the time.
- Demo Account: If your brokerage offers it, practise on a demo account before staking capital. These accounts are the perfect place to trial your strategies and get to know the platform you are using.
- Robots: For those wishing to make their lives easier, trading bots like the QProfit Systems forex and CFD trading robot are a great way to remove much of the manual labour. Bots can be set up to follow a predetermined strategy, including implementing risk management processes, over a range of markets. They will both open and close positions, so you need only monitor it sometimes.
Final Word On CFD Forex Trading
CFD forex trading is a way to speculate on the foreign exchange markets without physically converting currencies. Investors can make use of high leverage rates and simpler fee structures than their spot forex counterparts. However, it is important to implement robust risk management systems and carry out detailed research to guide your strategy. See our list of recommended CFD forex brokers and follow the guide above to get started.
Why Is CFD Forex Trading Illegal In The US?
Part of the reason is that they are an over-the-counter (OTC) product. This means they don’t pass through regulated exchanges and hence the US have banned them.
Is CFD Forex Trading Legal In The UK?
CFD forex trading is legal in the UK, whether you use a regulated broker or not. However, Financial Conduct Authority (FCA) regulated brokers have several restrictions and rules they must abide by to protect their clients, including segregating bank accounts.
Is CFD Forex Trading Taxable In The UK?
Yes, CFD forex trading is taxable in the UK. While you won’t pay stamp duty, profits are eligible for capital gains tax (CGT), unlike spread betting.
What Is The Difference Between CFD Forex Trading And Spread Betting?
Spread betting is very similar to CFD forex trading in that they are both forms of financial speculation using derivatives products.
However, where CFDs can be closed whenever the investor wishes, spread bets have a fixed expiration date (though they can be exited before this). Moreover, CFDs are charged commissions and fees, with taxable profits, where spread betting brokers make money from spread markups and profits are tax-free.
What Is The Difference Between CFD And Forex Trading Vs Share Trading?
CFD forex trading is very different from share trading, be it a spot or CFD itself. The main difference is the underlying assets, with forex CFDs based upon the performance of a pair of currencies, where shares are based on company stock prices.