One of the main reasons that contract for difference (CFD) trading is now so popular is that this form of derivative trading can apply to a wide range of underlying assets. Prices rise and fall in financial markets across the world dealing with many different commodities and units, but for many, the attraction of CFDs still ties in with stocks and forex markets.
Comparing forex trading to trading stocks involves some simple but basic differences for those looking to buy assets in the traditional way. Do these factors remain the same for those looking to use a CFD approach?
There are several reasons why a trader might prefer one market to the other, and as with many other aspects of both CFD trading and traditional “purchase” trading. these will often come down to personal preferences and the character and mindset of the individual involved.
A trading plan
Everyone embarking on a journey into trading needs a plan. At the basic level, this must include choosing an approach that will often mean deciding on a financial instrument or product.
The choice will be determined by factors such as available capital, how “hands-on” the trader wants to be and an assessment of a risk/reward ratio that is acceptable. Furthermore, time scales can vary greatly, and this is something to consider when choosing CFDs over other methods of trading.
Someone looking for a small number of trades that can produce a significant return versus someone who likes the idea of making numerous short-term trades will have different aims right from the start, so building a plan often takes care of itself in the initial stages after traders identify their key aims.
Stocks vs forex in CFDs
Stocks are often long-term buy-and-hold investments, and so-called blue-chip companies weather each market storm because investors have faith in their long-term stability. However, when the markets are volatile and particular companies have a rise or fall in fortunes, this can present perfect opportunities to take a position using CFDs.
Forex markets are generally much more volatile on a day-to-day and week-to-week basis, with short-term price swings lending themselves more to traders with little interest in holding positions over significant lengths of time. However, the quick pace of forex movements does mean that a significant investment in terms of time and interest is necessary.
In terms of leverage, high volumes usually indicate that there is a greater chance of a trader getting a good deal from a broker. A high level of trading on forex markets is therefore one of the reasons why CFD providers will usually offer far greater leverage than on stock trades, making it easier for a trader to take larger position sizes.
Of course, leverage maximises the possible return on investments, but it also increases risk. This is another way in which the mindset of a CFD trader differs from those of investors who usually choose more traditional methods. In terms of stocks and forex for CFDs, leverage is yet another aspect that makes up a trader’s toolkit, and when used wisely, it can provide a valuable set of options that might not otherwise be available.
With this year’s news of Apple becoming the world’s first trillion-dollar company by market capitalization, the stock markets were once again in the headlines as being awash with money. However, when it comes to CFDs and an interest in price movements, the issue of shareholder influence does become a factor.
A large institutional investor such as a major hedge fund can actively affect stock prices by its own actions simply because the volumes of shares that it holds are so large. This means that a tracked price can move without much warning in opposition to a trend, and analysts and industry commentators can also affect individual share prices.
CFD traders have to take these factors into account using stock markets, which are by their very nature somewhat unpredictable.
Forex markets are different because of the size of transactions, with latest estimates seeing $4tn traded on any one day. Although announcements from central banks or the major ratings agencies can have significant impacts, no single source can have as large an impact on the overall market as it can on individual company stocks.
In essence, this means that no matter how big or small forex markets players may be, they all operate on a much greater level playing field. For CFD traders who combine chart and technical analysis with news strategies, this can be a major bonus.
Freedom of choice
Freedom of choice is obviously clearly available on both stock and forex markets, but again, this can work in different ways.
Stock markets around the world offer thousands of individual stocks on many different exchanges, and these range from the legendary blue chips to tech-sector start-ups, with even more variety found in smaller start-ups and new floats.
On the other hand, the forex market consists of small combinations of major forex pairs and a slightly larger choice of minor pairs. Although there are new cryptocurrencies emerging all the time, they will never be anywhere near the number of listed companies available to base trades on.
Another appeal that CFD trades offer for many is the time aspect, and again, forex scores high here. Stock exchanges around the world open and close at certain times, while forex operates at any time during the trading week. So, while CFD trading based on stocks offers freedom in terms of the number of company options, forex-based trading offers flexibility in terms of trading hours.
One or the other?
When taken all together, there are undoubtedly advantages to both stock-based CFD trading and a forex-based approach. In each case, it is usually an either-or situation. The challenge for CFD traders is to identify exactly which kind of methodology that they want to employ and pick the markets and trades that best suit their own individual requirements and needs. This does not actually preclude using both stocks and forex at different times.