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What is the Difference Between a CFD and Forex Trading?

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  • Written By: Dana DeCecco
  • Edited By: A. Joseph
  • Last Modified Date: 24 August 2016
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Both a contract for difference (CFD) and forex trading are highly leveraged financial instruments. A CFD is a financial derivative with a specific underlying asset. Forex trading is the exchange of international currencies. The main difference between a CFD and forex trading is the investors' reason for investing. Most investors trading CFDs are primarily interested in financial speculation or hedging, and forex is traded for a variety of reasons.

Day traders and other speculative traders are attracted to CFD and forex trading because of the leverage available. Some brokers offer CFD and forex trading from the same platform and same account. CFD trading exists in many countries but is prohibited in the United States because it is unregulated.

CFD and forex trading are both international financial instruments. A contract for difference can be traded on international commodities, indices, treasuries and shares. CFDs are cash-settled, and no ownership rights of the underlying asset are transferred. Both short and long positions can be opened depending on whether the trader holds a bullish or bearish sentiment on the asset.

Foreign exchange trading is done on a worldwide scale. Currencies are not normally traded through a central exchange. Forex is decentralized and trades primarily over the counter. Currency values are traded relative to another currency. Trades are made in currency pairs, with one currency being used to buy another.

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Forex can be traded for speculation, but the primary reason is to aid in matters of international trade and investment. Currencies are traded by central banks, corporations, institutional investors and small speculators. Forex trading is also used for hedging purposes. Forex can be traded in the CFD market, but most currency traders use forex brokers and banks.

The CFD market was originally created for hedging purposes. Existing positions in equities and commodities can be hedged using CFD contracts. Unlike option contracts, CFD contracts do not expire. Overnight contracts must be rolled over, and the CFD provider might charge different types of fees. There is no regulation, so these fees might vary.

Although most forex transactions are made over the counter, currencies can also be exchange-traded. Futures contracts are available on major currencies. Some currency contracts are available in mini and micro units, suitable for smaller traders. Option contracts are also available on currency futures contracts. Forex exchange traded funds (ETFs) provide currency trading to the equities market.

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