The foreign exchange (forex) or FX market is one of the most actively traded markets worldwide. In simple terms, it involves the trading of currencies, which facilitates the worldwide trade of services and goods across borders. With the potential for attractive gains and fast returns, the forex market is one of the most popular amongst traders. However, the market is volatile which puts your capital at risk.
You could employ forex trading strategies to help to reduce this risk. When considering which strategy is best for you, you’ll need to take into account your personal goals, as well as how much you are willing to lose, and the level of risk you wish to take.
Two of the most popular ways to trade forex are through a contract for difference (CFD) or futures contract. In this article, we’ll take a look at exactly what these are, as well as the differences and similarities between them, to help you to find out which best suits your trading style, so you can make the most out of your capital.
A futures contract is a legal agreement to buy or sell a security or asset at a predetermined price, at a set date and time in the future. The buyer of the contract is obliged to receive the underlying asset when the futures contract expires, and the seller of the contract is agreeing to provide and deliver the asset at the specified date.
A futures contract allows an investor to speculate on the direction of the underlying asset for either a long or short trade, with the additional use of leverage. Futures are also used by traders to hedge the price movements of the asset in an attempt to limit the extent of any losses that may be incurred, caused by unfavourable changes in the market.
Futures are available on a variety of assets, such as stock exchange indices, commodities such as oil and gold, as well as currencies.
Contract for difference (CFD)
A contract for difference is essentially a contract between a buyer and a seller, stating that the buyer must pay the seller the difference between the current value of an asset, and its value when the contract ends. CFDs allow traders to speculate on the price movement of an asset, without actually owning it. Trading CFDs provides you with access to a variety of global markets, and whilst the value of a CFD doesn’t always reflect an asset’s underlying value, it does behave similarly to the underlying market, and is a flexible way for traders to take their place on the market. You can open and close a trade at any time, based on your predictions of the market’s movements, helping you to hedge your losses and make the most out of your capital.
On top of this, CFDs also offer the potential for even more gains, with the use of leverage. You’ll be required to supply a portion of the trade’s total value, much like a deposit, but essentially increases the potential of the gains that you could make on your position. It’s important to bear in mind, however, that leverage will also increase your vulnerability in terms of the losses that you could generate, so extensive research and planning are key.
Both futures and CFDs are available on a variety of global markets, so you can speculate on the market’s movements, without ever owning the underlying asset. In addition, they both allow the use of leverage, as well as the flexibility of taking out a long or short trade.
Due to futures being traded in a large, moderately liquid market, prices reflect the value of the underlying asset closely, whereas CFD prices are computed from the value of the underlying futures market, and then adjusted to suit the broker. Despite this, one CFD is usually equal to one asset, which isn’t the case with futures. CFDs are contracts between the broker and trader, and a futures contract is taken out between a buyer and a seller.
What’s more – futures are required to have a set expiry date as part of the contract, whereas CFDs can be open and closed at any time, helping traders to hedge their losses, and potentially make a profit.