CFD Forex: What it is and How it Works? 

Forex CFDs are one of the most common trading tools you’ll find on your CFD trading platform. In this guide, we go through what Forex CFDs are, how they work and how you can trade them in Australia. 

What is CFD? 

Contracts for Difference (CFDs) are a category of financial derivatives. These contracts enable traders to speculate on the price movement of financial assets like stocks, commodities, indices, or currencies without actually owning the asset. When traders are trading CFDs, the actual assets are not exchanged between the involved parties but instead, they agree on the price difference of the asset’s value between the opening and closing of the contract. 

CFDs offer a way for traders to possibly take advantage of market opportunities, during both rising and falling markets, by predicting the direction of price changes. 

Things to Know Before Trading CFD Forex 

There are a few things that traders should know before trading CFD forex, including the importance of trading terms such as currency pair, lot size, leverage, and spreads.  

Here’s what each of those key trading terms mean: 

Currency Pairs  

Foreign exchange trades happen in currency pairs. That way, you’re buying one currency of the pair while simultaneously selling the other ^[1]. 

Take the EUR/USD pair as an example. You have the base currency on the left, which is the EUR. This base currency is also what you’re buying. You have the quote currency USD on the right, which is what you’re selling.  

So, if the EUR/USD pair trades at 1.4400, that means it takes USD 1.44 to buy 1.0 EUR. If the price of this pair moves up to 1.4800, that now means you’ll have to pay more US dollars (at USD1.48) to buy 1.0 EUR.  

Lots  

To standardise the forex market, currency pairs trade in lots. Lots, in essence, are batches of currency. Since price changes in currency markets are often small, lots have to be significant to take full advantage of these movements.  

In Forex, a standard lot is 100,000 units. Of course, you can trade in fractional lots. Most brokers offer mini (10,000 units), micro (1000 units), and nano (100 units) lots. 

Margin 

In forex trading, ‘margin’ refers to the initial amount of money that a broker requires traders to have in their trading account before they start trading. Margin is also a small amount of capital you need to put up to open and maintain any forex position with the broker. 

This minimal capital serves as collateral or assurance to your broker that traders can manage the trade until it is closed. The margin is usually expressed as a percentage of the total size of the position you plan to open. Different brokers and currency pairs may have varying margin requirements, but they typically range from 0.25% to 10% or more. 

Leverage 

Leverage enables traders to control a larger position with a smaller amount of their own funds by borrowing the remainder from your broker. It is typically determined by your broker’s margin requirement and is commonly shown as a ratio.  

Different brokers have their own set margin requirements which affect the leverage ratios they offer, and these ratios can also vary across different asset classes. If a broker has a higher margin requirement, it usually results in a lower leverage multiplier for your capital, whereas a lower margin requirement often results in a higher leverage multiplier. 

How Does CFD Trading Work? 

CFD trading works by allowing traders to speculate the price movements of different assets through a broker such as Vantage without actually owning that asset. This process will allow the trader to speculate on the price difference of the asset when it is opened and when it is closed. For this example, we will look at Forex CFDs and how they work. 

Forex CFDs work similarly to CFDs in other asset classes. It also comes with all the features, benefits, and risks of different CFD types. For example, you can still take advantage of market opportunities in a bull or bear market with online CFD trading, as long as your price predictions are accurate. 

Let’s look at some features present in Forex CFD markets. 

1. Leverage in Forex CFDs 

Forex CFDs are leveraged, which means you can increase your exposure in the forex exchange market without having to pay the full price of the asset from the start. 

In Australia, with Vantage, you can trade major Forex CFDs currency pairs with 30:1 leverage. This equals a margin percentage of 3.33%.  

Say, for instance, that you’d like to trade the EUR/USD (Global: USD/GBP) forex pair. 

If you want to open a long EUR/USD position with a notional value of $1,000. The initial amount needed to fund this position would be $1,000 x 3.33% = $33.3. This simple example highlights the power of leverage, with a deposit of $33.3 allowing the trader to gain exposure to $1,000 worth of EUR. 

Using leverage in Forex CFDs can present both massive opportunity and risk. Your profit and loss are still calculated on the full size of your position. While you can make huge profits trading CFDs, you can also make huge losses that exceed your capital. 

2. Margin in Forex CFDs 

You require a minimum amount of capital in your account to open a forex CFD position. This minimum amount is called the margin. There are two types of margins: 

• Initial margin 
• Maintenance margin 

A deposit margin is pretty straightforward. That’s the amount you need to open a leveraged CFD position in the forex markets. 

Maintenance margin is what you need to keep your forex CFD positions open. If your trade gets close to incurring losses that your deposit margin or any other extra funds in your account cannot cover, then the maintenance margin keeps your positions open. 

Without maintenance margin, once you get close to incurring losses, your broker may stop you out of your positions and give you a margin call –a request to add more funds to your trading account.[2] 

3. Hedging in Forex CFDs 

More sophisticated traders can use Forex CFDs to hedge their positions. Hedging involves holding two (or more) positions on one asset simultaneously to offset any losses from one position with potential profits from the others.^[3]

4. Fees in Forex CFD 

To trade Forex CFDs, you’ll have to pay some costs and fees. Let’s take a quick look at them: 

• Spread is the difference between buying and selling prices on the forex pair. Every Forex CFD trade you make pays a spread. You can consider opting for currency pairs with narrower spreads because any slight movement in favour of your predictions means you can take advantage of market opportunities.^[4] 
• Depending on your broker or jurisdiction, you may also pay Commissions when you trade some forex CFDs. 
• To access additional data to help with your trading, you may pay market data fees that keep you up to date on your favourite currency pairs 
• You may have to pay your broker holding charges to keep your position open overnight. These fees may be positive or negative, depending on how your open trades go. 

Is Forex Trading Different from CFD Trading? 

Forex trading is different from CFD trading. Here are some fundamental differences between these two instruments: 

• Forex trading is limited to currencies, while CFD trading covers more types of assets. For example, you can trade commodities, indices, futures, stocks, and even cryptocurrencies using CFDs.  
• Regardless of the currency pairs, you choose to trade, lot sizes are uniform in all forex markets. For CFDs, however, you can trade a wide range of contract sizes across different asset classes. 

How to Trade CFD Forex in Australia 

If you want to start trading CFD forex today in Australia, here are some quick steps to get started. 

1. Open and fund your trading account 
2. Develop a trading strategy 
3. Choose your currency pair 
4. Open your first forex CFD position 
5. Monitor and close it

1. Create and Fund Your Trading Account 

Setting up a trading account for your Forex CFDs in Australia can be done in a few steps. Choose a broker such as Vantage and follow the steps to open an account on their website. Once you’ve completed the verification details like your ID and proof of address. Once your trading account is approved, you’ll need to pass the Client Suitability test. After that, you’ll get instant access to the forex markets,  

To begin trading, connect your credit/debit card/bank account to your trading account to fund it. Most brokers have promotions, bonuses, and deals for new accounts as per the applicable legislation. Take advantage of them to get started on your trading journey with a boost to your new trading account. 

2. Develop a Trading Strategy 

A trading strategy is how you manage your risk and plan how to use your capital to make trades. It also helps you determine acceptable losses and profits. Ensure you use fundamental and technical strategies to analyse your chosen forex pair before opening a CFD position ^[5]. 

3. Choose Your Currency Pair 

Choose your currency pair based on your strategy. You can also choose currency pairs on either spot CFD markets or forex options markets. You can start with a single pair or trade several currency pairs simultaneously. 

Some popular currency pairs you can pick from include: 

• EUR/USD (euro/US dollar) 
• USD/JPY(US dollar/Japanese Yen)  
• AUD/USD (Australian dollar/US dollar) 
• GBP/USD (British pound/US dollar) 

Interested in learning more about different currency pairs? Read our article on the ‘6 Major Forex Pairs‘ to better understand them. 

4, Open Your First Forex CFD Position 

Open your first forex CFD position by buying or selling your chosen currency pairs from your trading platform. Buy the pair if you expect the base currency to rise in value or sell the base currency if you expect the value of the quote currency to rise. 

You may consider placing stops and limits on all your open positions. Stop losses and limits are essential tools in managing risk and reducing exposure. 

5. Monitor Your First Position and Close It 

You can now monitor your open positions on your trading platform. Some platforms send you trading alerts as push notifications, emails, or via SMS. 

Final Thoughts 

Forex CFDs are an excellent way to take advantage of market opportunities from the forex markets without actually owning the underlying currencies.

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