A ‘contract for difference’ is commonly abbreviated as ‘CFD’. It is a form of trading that allows you to speculate on the price movements of different asset types, like currency pairs, shares, commodities or even cryptocurrencies*. Rather than settling the underlying asset, you are trading on the price movement of the underlying asset.
Below we will look at forex CFDs in greater detail.
If you are looking to trade forex CFDs, then you need to understand the underlying foreign exchange market. CFDs simply represent an alternative means of trading on forex currency pairs.
A forex quote consists of two currencies; the base currency and the quote currency. The currency pair can be a reflection of the strength of one economy versus another, and the exchange rate is a function of the relationship of the two economies. You should try to understand and consider the various technical, political, and economic events that have the greatest effect on each currency.
When you have a firm grasp of the fundamentals of a particular currency pair, you can then investigate how CFDs work.
The basis of forex trading is the exchange of a certain amount of one currency against another. For instance, if you were to purchase GBP/USD, you would profit if the pound appreciated against the US dollar (GBP/USD moves higher) or lose money if the exchange rate falls (GBP/USD moves lower).
CFD trading allows you to place leveraged trades on currency pairs, speculating on the movement of the underlying instrument. Rather than settling (or delivering) a set amount of base currency, CFDs are cash-settled, based on the difference between the opening and closing prices of a pair of currencies.
One of the key features of CFD trading is that by using leverage you can increase your trade size while committing a relatively small amount of capital. You should keep in mind that while increasing your exposure magnifies potential profits, it also magnifies potential losses.
Forex can be traded as futures contracts or as CFDs however there are significant differences between these two financial derivatives. One difference is that futures are most often traded on exchanges, while CFDs are offered over-the-counter (OTC). Futures contracts - such as those based on Oil, Natural Gas, Gold, and more - have an expiration date. It is an agreement to buy or sell a certain asset at a fixed date in the future at a predetermined price. In contrast, a forex-based CFD does not have an expiry date and can be closed at any time. It should also be noted that CFDs are short-term speculative products and not intended to be held for long periods of time. Profits or losses are determined by the difference between the opening and closing price of the contract. In a CFD transaction, the issuer (for example, Plus500) acts as the counterparty, while in the futures market, the broker acts as an intermediary, as opposed to a counterparty.
Similar to most derivative products, leveraged CFDs are risky in comparison to actually trading the underlying asset because of your increased exposure (which can also lead to potentially higher profits but also higher losses). Plus500 offers a range of risk management tools that can help you take control of your trades and manage your risks. These include ‘Close at Profit’ (to close trades when they reach a certain level of profit), ‘Close at Loss’ (to limit risk to a certain value), ‘Guaranteed Stop’ and ‘Trailing Stop’.
As with any trading, you should always keep in mind the golden rule: you should never trade more than you can afford to lose.
Plus500 has a range of powerful technical analysis tool to help you control your trades and develop strategies. If you want to test your strategies and see how CFDs operate in real-time and real market conditions, you can start by trying our risk-free Free Demo Account - which lets you practise before you trade with real money.
This article contains general information which doesn't take into account your personal circumstances.
*Instrument availability varies by operator.
Cryptocurrency CFDs are not available to Retail Clients.