CFD Trading in the Forex Markets
CFD trading in the forex market is a relatively new, but increasingly popular phenomenon. There are many similarities between CFD forex trading and trading CFDs on stocks, but there are also important differences.
If one trades a CFD on the shares of a particular company, one can either go long or short, but not both – unless two different trades are opened. With Forex trading this is different since one currency is always quoted in terms of another currency, e.g. AUD/USD or GBP/Euro. A trader that goes long in one such currency is automatically short in the other currency. Being long on the AUD/USD is therefore simply a way of saying that one is short on the USD/AUD.
Something else to remember is that most currencies are quoted in terms of the US Dollar. This has important implications regarding risk. A trader who is long on ten different currency pairs, all of which are quoted against the US Dollar might not have a properly diversified portfolio at all, because if one of these currencies starts to go down the others might theoretically all follow suit. This would not necessarily happen, but it could and this possibility needs to be taken into account. A comparison would be to trade only in shares in a particular industry. Any news which affects the industry as a whole could have a significant effect on all the shares in that portfolio.
CFDs on individual stocks can sometimes be extremely volatile. This is usually not the case with major currency pairs such as the GBP/EURO or USD/CHF. This is because the market is huge and major players are not as easily able to affect price movements with their trading activities.
CFD traders looking for short term action should rather concentrate on emerging market currencies such as the Polish Zlotny or the Australian Dollar. Fig. 10.25(b) below is an hourly chart for the AUD for 23/24 May 2012. One can clearly see the large upward and downward price spikes and how the market gapped.
While CFDs on individual shares can usually only be traded when the particular stock markets are open, forex CFDs have much longer trading hours. They can virtually be traded around the clock five days a week. Markets in the Far East will open first, followed by those in Europe and finally, when they are closed the American markets will start to open – resulting in a worldwide market that can basically be traded whenever it suits the individual trader.
This of course also has its drawbacks. Anyone trading without a stop loss in such a market could wake up in the morning to find that his or her trading account has evaporated overnight.
The leverage on Forex CFDs can be as high as 100:1 or even 400:1. This effectively means the trader can take on all the potential profits and risks of an investment 100 or 400 times the amount which he or she has available to trade with.
Remember though that with higher leverage comes not only higher profit potential, but also higher risk. A 400:1 trade only has to move 0.25 percent against the trader before it will wipe out the amount which he or she risked on the trade. A 0.25% movement in the ‘right’ direction will of course double the initial investment – which is what lures so many would-be millionaires to the arena of CFD trading.