The financial markets enable the trade of various instruments, such as commodities, securities, shares, derivatives and currencies. The foreign exchange (forex) market involves the trading of currencies, and is one of the most popular markets amongst traders, as it has the potential for high gains and fast returns. This does mean, however, that the market has high volatility and an increased risk.
Despite this, there are many basic forex trading strategies and indicators (or you can use forex signals providers) which can help you reduce risk. When considering which trading strategy is best for you, you’ll need to take into account your personal goals, alongside how much risk you are willing to take. Two popular types of trading include a futures contract, or trading a contract for difference (CFD).
In this article, we’ll take a look at what are futures contract and trading CFDs, as well as the differences between the two, so that you can find out which trading strategy works best for you.
Futures contract
A futures contract is a legal agreement to buy or sell a specific commodity, asset or security at a price that has been predetermined, at a set time in the future. The person who buys the futures contract is obliged to buy and receive the underlying asset when the futures contract expires. The seller of the contract is agreeing to provide and deliver the asset at the set date of expiry.
On top of this, a futures contract allows an investor to speculate on the direction of financial instrument, security, or a commodity such as oil and gold, for either a long or short trade, with the additional use of leverage.
Futures are also commonly used by traders to hedge the price movement of the asset, helping to prevent any losses that may occur due to any unfavorable changes in the market. They are available on a huge variety of types of assets, such as stock exchange indices, commodities, and currencies.
Contract for difference
A contract for difference (CFD) is a contract between a buyer and seller that states the buyer must pay the seller the difference between the current value of an asset, and its value at the time of the contract.
When CFD trading, the contract is an agreement between an investor and a CFD broker to exchange the difference in value between the opening and closing of the trade.
By trading CFDs on investments global, investors can speculate on the movements of a huge variety of global markets, all in one place, without actually owning the underlying asset. The value of a CFD doesn’t always reflect the asset’s underlying value, but does behave similarly to the underlying market. The profit or loss is determined by the change of price between the entry and exit of the trade.
Trading CFDs not only allows the investor to speculate on the price movements on a variety of global markets, but enables the use of margins and leverage, to offer the potential for even bigger gains. It’s important to remember, however, that leverage can be a double-edged sword — the greater the potential gains, the greater the potential losses can be too.
The differences
Futures are traded on open, public exchanges, and can be bought and sold by a range of different investors and institutions. Due to this, futures contracts are generally traded in a large, moderately liquid market, making prices reflect the value of the underlying asset more closely. Whereas many CFD prices are computed from the value of the underlying futures market, and adjusted to suit the broker.
Some believe that futures contracts are more effective for high quality trades, because of the nature of the commission structure. However, futures also tend to have less liquidity than CFDs. CFDs are largely traded directly with the broker, who commonly acts as the market maker in situations where positions cannot be directly matched.
On top of this, futures contracts are usually more expensive for smaller traders to invest in due to the rigid size of the contracts involved. However, one CFD is usually equal to one asset, which isn’t the case with futures. Traders are likely to be required to fund a large amount of capital upfront in order to acquire interest in the futures market, making CFDs appear more flexible in allowing traders to take positions on the market.