In general terms, Forex CFD is identical to Spot Forex Trading. It is a derivative investment product whose price is based on or ‘derived’ from the spot price of the underlying currency pair. There is a Forex CFD product for all major currency pairs and for a number of minor currency pairs. But unlike Spot Forex, where your order is coursed through the foreign currency market where participants are electronically linked and where you never know really know who matches your trade, with Forex CFD you are trading against a CFD provider who happens to be your broker.
CFD stands for ‘Contract for Difference’ which basically is a contract between you (trader) and your broker (CFD Provider). With Forex CFD, the trader buys or sells shares or units of the currency pair in contrast to the standard whole sale contract sizes in Spot Forex. A share or unit of Forex CFD is at most worth $10,000 while it is $100,000 minimum for Spot Forex. Forex CFD is more like the mini and micro accounts in spot foreign currency trading.
However, in spot foreign currency trading, all buy and sell orders carries an underlying obligation to either accept delivery of the currencies you bought or make actual deliveries of the currencies sold if and when the situation demands. You must remember that the major participants in the forex have a real natural interest on the currencies they are trading. They include exporters and importers, banks, multinational organizations, etc. who have a constant need for different currencies as a consequence of their business transactions with other countries.
The volume of trade from individual investors who belongs to what we now call as retail forex trading is but a mere 5% of the total daily turnover of the spot forex market. The retail forex traders are there just to speculate for profits and they are able to avoid the above mentioned obligations associated with currency contracts through roll-overs or by early liquidation.
On the other hand, Forex CFDs carries no such obligations to accept or make actual deliveries. In other words, it is purely for speculation purposes. Its real value is in providing an investment vehicle where investors will be able to hedge their currency risks. For example, an exporter who worries about currency rate fluctuations may buy or sell CFDs to lock in or preserved the current value of their export contracts so that where ever the rates go they will be protected. If the rates of exchange between the currency of the country where the exporter comes from and the currency of the country to which he has contracted to sell his products becomes unfavorable to the exporter at the time payment is made, the exporter will be able to recoup his losses in the export transaction if he hedged his risks with Forex CFD.
Almost all of the individual investors who engage in retail forex trading do so only for speculative purposes. Forex CFD offers them the same opportunity to speculate for profits on essentially all major currency pairs without worrying about rollovers and rollover interests. The only limiting factor to Forex CFD is it is a relatively new investment instrument and its liquidity is tied up to the integrity and stability of the broker who is also the CFD provider.
