Forex Trading Beginners - FX cash, CFD or Spread Bet?
Submitted by akordionline on Sat, 09/25/2021 - 13:16
The Foreign Exchange market is the most traded global market in the world, attracting more and more retail customers, who hope to take advantage of changes in currency pair prices. Using a trading platform will allow you to access different leveraged products for short term trading, such as spot Forex, CFDs, or Spread Bets. These products are the three ways you can trade the FX market. They are similar as they are all margined products, but they have a few differences that we will explain below. WHAT IS FOREX TRADING? To put it simply, the Forex market is a financial market that allows for the exchange of different currencies. Participants in this market can be governments, central banks, businesses, or individuals. You’ve likely already participated in the Forex market, even if you didn’t realize it at the time. When you travel to a different country, say from the UK to France, you need to deal in the local currency in this case, the Euro – as nobody in France would accept pounds. So, you go to a currency exchange company and get your pounds changed to euros. This is Forex trading, albeit on a small scale. Forex trading is investing in currency pairs Buying or selling currencies in the Forex market is done via currency pairs (EUR/CHF, GBP/USD, AUD/NZD). What this means is that you’re always buying one currency and selling another one at the same time. As Forex prices are always quoted in pairs, there are two currencies: a base and a quote currency. Base currency vs. Quote currency The first currency is called the base currency, while the second one is called the quote currency. The price quoted represents the value of 1 unit of the base currency in the quote currency. For instance, if the EUR/USD is quoted 1.1600, it means that 1 EUR equals 1.1600 USD. Long vs. Short position If you want to invest in the EUR/USD currency pair, you can either open a long position, or a short position. If you have a long position, it means that you believe that the EUR will strengthen against the USD. You’re expecting the currency pair to go up. Conversely, if you hold a short position, it means that you think that the EUR is weakening against the USD, and you’re hoping that the currency pair will go down. No central exchange system When trading the Forex market, there is no central exchange. This means that investors use different networks of banks and dealers to buy and sell currencies. This is called an OTC market, which stands for “Over The Counter”. In an OTC market, the trading counter-party of a transaction isn’t an exchange, but the institution that allows the transaction, such as your broker or bank. This means that prices aren’t regulated by one organisation, or governing body – price movements follow market dynamics. The Forex market is the largest market, open around the clock The Forex market is the largest financial market in the world. There is on average US$ 5.1 trillion exchanged every day on the currency market. Because there are different trading sessions (the Asian, European and North American sessions), FX traders are able to make financial transactions 24 hours a day, 5 days a week. PROS AND CONS OF FOREX TRADING As with any type of trading, Forex trading has its upsides and downsides. Before entering this market, you must carefully analyse the benefits of Forex trading in light of the dangers of Forex trading, weighing up each to determine if this is the right market for you. Advantages of Forex trading Flexibility Accessibility Low barrier to entry Leverage Volatility High liquidity Low transaction costs Ability to profit from falling as well rising price moves Ability to automate trading strategies Variety of currency pairs to trade Disadvantages of Forex trading Leverage Volatility Light regulatory protection Lack of transparency WHAT IS CFD TRADING AS IT APPLIES TO THE FOREX MARKET? Trading CFDs, which stands for Contract For Difference, represent a financial contract between a trader and his broker to exchange the difference between the opening price and the closing price of a currency pair. Expert tip The only things you need to know before opening your CFD contract are: The direction of the currency pair (upwards, downwards) The number of contracts on the pair you want to open How much a point is worth Every time the price of the selected currency pair moves in your direction, you will gain the value of the points (determined in advance by your broker) times the number of points by which the pair has moved in your favour, and vice-versa. WHAT IS SPREAD BETTING TRADING WHEN CURRENCY TRADING? A spread bet is a derivative OTC product that allows you to enter in a deal with your broker by betting on the direction of a price of a currency pair. The way spread betting works involves buying or selling a predetermined amount of money per point of movement of the currency pair you want to invest in. Before opening a position, you will have to determine the price you want to bet per point, which represents your stake size, or your bet size. Every time the price of the selected currency pair moves in your direction, you will gain your stake times the number of points by which the pair has moved in your favour, and vice-versa. ADVANTAGES OF CFD TRADING AND SPREAD BETTING CFD and Spread Bet trading allow you to take advantage of the rise or fall of the currency market, which means that you can win regardless of the direction the market takes. These products are based on margin trading, which means that you only need to put aside a small percentage of the full value of the Spread Bet/CFD to be able to open your trading position and keep it open – ideal for small portfolio sizes. Margin trading and leverage allow you to invest more money than you actually possess in your account, which means that you get greater exposure to the FX market, as well as the ability to open more positions. Did you know? The main advantages of Spread Betting are that profits are exempt from capital gains tax* in the U.K. and in Ireland. It’s also commission-free, as all the associated costs are included in the bid-offer spread. The biggest benefit of CFD trading is that you can use your losses to lower your taxes*. Of course, the ways taxes are computed depends on individual circumstances, and are subject to changes in tax laws. DISADVANTAGES OF CFD TRADING AND SPREAD BETTING The disadvantages of spread betting are roughly the same as those of CFD trading and margined Forex trading, in the sense that they’re all margined products using leverage. Leverage is a great tool to increase your profits, but it’s a double-edged sword, as it can also amplifies your losses. Consequently, there are a lot of risks involved when using high leverage – not to mention that the underlying market – the FX market – can be a volatile market, which means that market prices can quickly move in either direction. As Spread Bets are tax-free, this means that you cannot use potential losses to lower your taxes, as you can with CFDs. FX CASH, CFD OR SPREAD BET? Whether you’re a beginner in Forex trading, a beginner in CFD trading, or a beginner in Spread Betting, you need to remember that margin trading and leverage are very risky tools. Risk warning CFDs, Spread Bets and margined Forex trading are complex financial instruments that come with a risk of losing money quickly. Your losses can exceed your deposit. For this reason, always add sound money and risk management rules to your trading plan. Before you take a position, always determine the potential profit you want to reach, as well as the loss you are willing to accept (set a stop-loss order). The best thing to do would be first to learn more about how to trade Forex, CFDs and spread betting and then open a demo account to get familiar with the trading platform and the FX market, test your trading strategy on it, and develop your patience and discipline. Spot market vs. the other leveraged products Of these three leveraged products, margined Forex trading (also known as “spot”, or “cash” Forex trading) was the first to be created. CFDs and Spread Betting came later, allowing regular private traders to access the Forex market – as well as many other financial markets – with lower transaction costs. Lots vs. contracts and bets In contrast to Spread Bets and CFDs, the Foreign exchange market trades in lots. This means that traders agree on a price for immediate delivery. There is an effective exchange of the underlying currencies with spot Forex, as it’s a cash transaction. On the other hand, with financial Spread Bets and CFD positions the trader never owns the underlying asset. There is no delivery of the underlying currencies, as are merely speculations on the future value of a currency against another one, based on the price provided by a Forex broker. Size of a contract With CFDs, a trader determines the size of his trading position by the number of contracts he opens, while with Spread Bets, he decides his position size depending on the value of a point. With CFDs, the broker is the one determining the value of one contract, while with Spread Bets, the trader is the one deciding the value of a point, or bet size. Profit and Losses With spot FX trading, profit and losses (P&L) are denominated in the quote currency. As there is a real exchange of currencies, the trader’s account will have different balances with the various currencies they traded. As currencies constantly fluctuate against each other, the total trader’s balance will change even though they didn’t place any FX trading positions, as they will own different currencies. With CFDs, the P&L is denominated in the base price, while with Spread Bets, you bet in the currency of your choice, meaning that your main concern is whether or not the currency pair will finish higher than the opening price. Spread Bets and CFDs can be illegal Nowadays, in countries like the US, retail traders do not have the ability to trade CFDs or Spread Bets to speculate on the currency market. Consequently, they’ll have to turn to Spot Forex trading if they want to exchange currencies. How much money can you make from Forex trading, CFD trading, and Spread Betting? Potential profits from Forex, CFD or Spread Betting trading will mostly depend on your account size, your risk per trade, and your leverage. For example Without taking excessive risks, and if you follow a sound trading strategy, you can assume that you can make between 5% to 10% per month, starting with a minimum of US$ 5,000 with CFDs and Spread Bets. DON’T FORGET THE TAXES A major factor that could change your profit or loss results are the taxes applied to each financial instrument. Margin Forex trading has similar rules to the taxes applied with CFD trading, meaning that you’ll pay Capital Gains Tax on profit, and your losses are deductible. On the other hand, Spread Betting activities are tax-free in the U.K. and Ireland, as you do not have to pay capital gain tax. Moreover, Spot Forex trading, CFDs, and Spread Bets do not incur any stamp duty.
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