Forex vs CFDs: Know the Differences and Similarities

In terms of global markets, whenever the question of investment arises in currency trade, the foreign exchange market is what we are all looking at. The price of one currency in terms of another is known as the exchange rate. This veritable exchange of currencies is the driving force behind the currency trade for any profitable venture. The demand and supply in the foreign exchange markets permit the establishment of the rate of one currency in terms of another. In the markets dealing with the exchange of currencies, it is not just that currencies themselves form the instruments, which means that currencies can be used further for the purchase of further instruments. 

Forex vs CFDs

In a true market sense, whenever a comparison arises between Forex and CFDs (Contract for Differences), it must be kept in mind that both Forex and CFDs involve the same mechanism of executing a trade deal. This means that the comparison charts and entry-exit timings for traders work in a similar manner for Forex and CFDs. Another major area of similarity between Forex and CFDs is the fact that in both these cases, the trader does not claim the full ownership of the underlying asset allocation as such. Currency futures are conceptually similar to currency forward. 

In both Forex and CFDs, the sole claim that any trader can actually have is the right over speculation of the price variations of a currency or a contract and not the actual currency or contract as such. This is akin to understanding how banks or financial units act while they are dealing with their clients; they act as an intermediary between seekers and suppliers of foreign currency. As far as their own interests are concerned, they may act as intermediaries or even as arbitrators of the trade deal, as and when required. Big commercial banks act as market makers, by quoting two-way prices, one for buying and the other for selling foreign currency. 

Similarities and differences:

The fact of the matter is that similarities between Forex and CFDs are rooted in the manner of execution of a deal and the platform for trading being the same. In both Forex as well as in CFDs, speculation overpricing difference serves as the instrument for profit-making and not the ownership of the asset in question. For instance, if we say that trader X earned a steep profit over trade in Rupees, it does not mean that the ownership of Rupee lies with the trader X.

Foreign exchange market is a market where different currencies are bought and sold. The price of one currency in terms of another is known as the exchange rate. Currency may be bought and sold either in spot or in the forward market. Spot market is the one where the exchange of currencies takes place within one or two days whereas in the forward market exchange of currencies occurs on a future date, though the rate is fixed today. Major participants in the exchange market are central banks, commercial banks, business enterprises and individuals. Foreign exchange market operators may act as brokers, speculators, hedgers or arbitrageurs. Brokers do not buy or sell themselves but enable buyers and sellers to come in contact with each other. For their services, brokers charge commission.

Speculators are risk-takers who take positions in the market, expecting that rates would move in their favour. Hedgers are generally business enterprises that like to cover their exposures. Arbitrageurs make riskless profits by exploiting price differences in the market. Normally rates are quoted with a buy-sell spread.

The major areas of difference between Forex and CFDs involve the spectrum of operations, which means that in CFDs, the products involve contracts, cryptocurrencies and commodities, whereas in Forex, the only product is purely based on the valuation of currency and does not go beyond that.

Entities like multinationals, who regularly operate in foreign reserves may also buy or sell currencies with a view to speculating or trade-in currencies to the extent permitted by the exchange control regulations. The deals between banks and their clients form the retail segment of the foreign exchange market. 

Tax burden can be minimized by judicious cost allocation between different units of the firm. If a firm allocates higher costs in a high tax country and shows greater higher profit in low tax country the overall tax burden can be minimized. However, there are limits to cost allocations, especially when intermediate goods transferred from one country to another attracts custom duties.

In India, there are guidelines for currency trading that lay down specific regulations for individuals or firms and even for financial units so that they can trade within the purview of those guidelines for currency exchange. The major reason for this is the possibility of any dispute that may arise due to any claims and/or counterclaims by either party.

It is important to mention here that the last line of difference between the Forex and CFDs is that factors that influence CFDs arise from the variations in demand and supply for commodities, while for Forex, these factors stem from events that influence the global currency valuations. 

The major commercial banks have the liquidity factor working in their favour and as such can leverage their operations in the market to a considerable extent. Depending on buying or selling foreign currencies at the rates quoted by them up to any extent. The net amount of resource allocation and fund management that a bank compiles and executes directly has an impact on its networkability in terms of trade execution as well. These financial players retain significant financial rights in order to ascertain the currency trade prices and thus act out in significance over the trading parties. This is where banking regulations come in when dealing with the role played by major commercial banks in Forex or CFDs.

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