Forex CFD Trading

Forex CFD trading combines one of the most popular asset classes with one of the most popular instruments. This guide will cover everything that you need to know – including examples, strategies, the pros and cons as well as risk-management techniques. Read on to find out more with Tradu.

Read our guide to forex trading

Forex CFD trading: What to expect from our guide

• What is forex CFD trading?
• What are spots, futures, forwards and options in forex CFD trading?
• The use of leverage and margin in forex CFD trading
• An example of forex CFD trading
• Forex CFD trading strategies
• What are the benefits of forex CFD trading?
• What are the risks of forex CFD trading?
• Risk management strategies for CFDs and forex trading
• How to trade forex via CFDs with Tradu

What is forex CFD trading?

Forex CFD trading is the use of contracts for difference (CFDs) to speculate on the price movements of currency pairs. It is a popular method for traders around the world because you can profit in both bullish and bearish markets, without having to take ownership of the underlying asset.

Instead, you are entering into a contract with another party to exchange the difference in a pair's price between the point at which you open the position and when you close it. If you believe that the base currency is going to appreciate against the quote, you go long or 'buy'. If you think that it will weaken against the quote, you go short or 'sell'.

Read our guide to CFDs

What are spots, futures, forwards and options in forex CFD trading?

Spots, futures, forwards and options are different markets for trading forex pairs. Please note these are not available with Tradu and are included here for informational purposes only:

• Spots are an over-the-counter (OTC) market where pairs are traded immediately – or on the spot. There is no set end date to the position and spreads tend to be tighter than futures, forwards and options.
• Futures are traded on a regulated exchange, rather than OTC. These exchanges set the trading parameters, so futures contracts are standardised in terms of their order sizes, expiry dates and other terms.
• Forwards are similar to futures but they are traded OTC, rather than on a regulated exchange. This means that the details of the agreement are bespoke and set by the buyer and the seller.
• Options also work in a similar fashion to futures but there is a key difference in that upon expiry date, there is no obligation to buy or sell. You simply have the 'option' to do so.

Read our guide on futures

The use of leverage and margin in forex CFD trading

When using CFDs for forex trading, you will do so using leverage and margin. This allows you to open larger positions while committing only a small percentage of the capital that would be required in a conventional trade. Meanwhile, you are essentially borrowing the remainder of the capital from your broker. This can amplify your profits and losses in equal measure, so it's important to be aware of the risks of trading in this way.

Leverage and margin are closely related terms but have slightly different meanings:

• Margin refers to the amount of capital that you need to put up in order to open a position. It is displayed as a percentage. As an example, let's say that your broker's margin requirements for a forex trade is 5%. If you want to open a position worth $10,000, your initial outlay would be $500. This is known as your deposit margin. Your maintenance margin refers to the amount that you need in your account to keep open a position. If this runs out, your broker will issue a margin call and may take steps to close a position on your behalf if you fail to act.
• Leverage is used to illustrate how many times that margin will be multiplied to work out the full value of your position. This is displayed as a ratio. In the example referenced above, your leverage would be 20:1. As one of the most popular asset classes, the forex market tends to provide higher leverage ratios.

Read our guide on leverage trading

An example of forex CFD trading

The US dollar/euro (USD/EUR) combination is the most frequently traded pair in the forex market, with an average daily turnover of $1.7 trillion, according to data from the Bank for International Settlements. Let's use USD/EUR as our forex CFD trading example:

• USD/EUR is trading at 1.09226 / 1.09236.
• You believe that the dollar is going to weaken against the euro, so you want to go short or 'sell' at the price of 1.09226.
• You place an order for a single CFD with a notional value of $10,000 and $1 per point.
• Your broker requires a 5% margin, so your initial outlay is $546.13 (5% of 10,000 x 1.09226).
• The market moves as you predicted, and the dollar weakens against the euro.
• USD/EUR is now trading at 1.09116 / 1.09126.
• You decide to exit your position and 'buy' at the new price of 1.09126.
• 1.09226 - 1.09126 = 0.001, or 10 points. At $1 per point, you have made a profit of $10.

The above example illustrates a winning trade. If your prediction had proved to be incorrect and the dollar had strengthened against the euro, with a movement of 10 points, you would have lost $10.

Forex CFD trading strategies

Traders will adopt one or more forex CFD trading strategies based on their level of knowledge, their objectives and the amount of time that they can dedicate to monitoring movements in the market. Common strategies include:

• Day trading: Opening and closing positions within the same day, avoiding overnight charges as a result.
• Trend trading: Using historic price movements to predict overarching trends in the performance of currency pairs.
• Swing trading: Predicting when a prevailing trend may be about to 'swing' back in the opposite direction.
• Range trading: Identifying where a pair's price tends to trade between certain resistance and support levels, and opening and closing positions within those values.
• Breakout trading: Recognising where a pair's price is set to defy or 'break out' of those upper or lower limits.

Read our guide on forex trading strategies

What are the benefits of forex CFD trading?

Forex CFD trading is popular among millions around the world and its key benefits include:

• Leverage: Trading on leverage offers you the opportunity to increase your market exposure for a smaller capital outlay. If the trade works in your favour, your profits will be amplified.
• Liquidity: The forex market is among the most liquid in the world, with trillions of dollars changing hands daily for major pairs such as USD/EUR. That level of liquidity makes it easier to enter and exit positions as and when you need to do so.
• Volatility: Currency pairs can offer high levels of volatility, so forex CFD trading can present opportunities if price movements work in your favour.
• Trade both ways: Using CFDs for forex trading enables you to speculate on a pair's performance in either direction. This means that you have the potential to make profits in both bearish and bullish markets.

What are the risks of forex CFD trading?

All forms of trading come with risk attached. Here are some of the factors that you need to consider when trading forex via CFDs:

• Leverage: Trading on leverage can pose a risk as well as a potential benefit. You are exposed for the full value of your position, not just your deposit margin, so your losses could be amplified if the trade does not work out as you'd predicted.
• Volatility: As with leverage, this is also a double-edged sword. Sudden and significant movements in the forex market can lead to you incurring unexpected losses.
• Margin calls: If you do suffer a sudden and significant loss, you may find that your maintenance margin is wiped out. That will prompt your broker to ask you to commit additional capital, or else you risk your position being closed.

Risk management strategies for CFDs and forex trading

CFDs are complex instruments and, as with any form of trading, you are at risk of losing money. That's why it's important for you to take steps to mitigate those risks by implementing some safeguarding measures. These may include:

• Take-profit orders: These can be set up to close out a position once your profits on a trade reach a certain level. The idea is to avoid holding a profitable position for too long to the point at which the market begins to move against you.
• Stop-loss orders: Like take-profit orders but in reverse, stop losses are designed to be triggered when the market movement is against you, thus capping any potential losses at a pre-determined level.
• Hedging: This is a tactic used by experienced traders and essentially involves taking up opposing positions in order to limit your losses so that, if one trade goes against you, the other will be in your favour.

How to trade forex via CFDs with Tradu

You can open a forex CFD trading account with Tradu in a matter of minutes, at no cost. Once you're set up, you'll have access to our proprietary platform where you can trade hundreds of major, minor and exotic currency pairs. You'll also benefit from our suite of analytical tools to help you monitor the markets and inform your decisions.

And if you want to know more about forex, CFD trading and other related topics, please check out our guides below:

Read our guide to forex trading

Read our guide to CFDs