The currency markets are far larger than the capital markets, with literally trillions traded every single day. A 24/5, fast-paced marketplace, the foreign currency markets are where serious investors make their fortunes, delivering the opportunity to capitalise on various different economic and political outcomes globally. A high-risk market to invest in anyway, as a result of the extreme volatility caused by differing exchange rates, currency trading becomes even more volatile and risky when CFDs are introduced into the mix, yet they deliver some crucial advantages to traders over direct investment, and CFDs remain a weapon of choice for many currency speculators.
Why Do Traders Buy Currencies?
When it comes to market volatility, there aren’t many markets that can compete with the international currency exchanges. Traded amongst retail markets, private investors, funds and governments, currencies allow speculation on interest rates and currency exchange rates to take place through a centralised, global market. Again, like shares and commodities, currencies have an obvious inherent value in them, representative ultimately of the strength of the issuing government’s central finances. With floating currency exchanges, traders can speculate through currencies on a number of key economic factors, and are effectively endorsing one economic outlook over another when choosing to back either side of a currency transaction. And with the extent of variation between currency valuations and daily exchange rates, the differential can be a substantial draw for traders looking to find that next investment opportunity.
Currencies are traded not only by traders, but also by companies and governments too – particularly those with exposure to currency fluctuations as a result of selling in multiple currencies or buying from abroad. This helps fuel capital flow through various different currencies and central banks, which as a result provides vital financial contributions to the relevant public coffers.
In their favour, currency markets are more directly sensitive to economic factors than, say shares or commodities, because their demand and supply is dictated only in response to the yield those currencies are likely to deliver (denoted through central interest rates) and the likely shift in value of the relevant currency against the trader’s base currency. As such, forex markets represent an arguably more narrowly defined investment opportunity than in certain other markets – though that’s not to suggest that currency is somehow an easier basis of investment to master than others.
How Are Currencies Invested In?
Currencies are heavily invested in and traded around the clock, by investors and traders of all shapes and sizes. The forex markets, which represent the main channel through which traders can buy and sell currency pairings, are by far the most popular way to trade in currencies, and the forex markets themselves are a subset of the financial markets traders spend years trying to master. Highly leveraged in their own right, forex transaction tend to be reasonably similar in practice to CFD trades, which makes them particularly interchangeable when it comes to trading forex through contracts for difference. Aside from trading in currencies directly through a forex broker, some larger institutions hold currency balances in their bank accounts, either domestically and/or internationally, to protect against their exposure to currency risk. In this sense, currencies can also deliver a yield in the sense that different accounts held in different countries will attracting differing returns based on central interest rates – for example, if US interest rates are higher than UK rates it might encourage significant inward investment from companies with international capital portfolios to the US in order to capitalise on a higher rate of return paid on the dollar.
Why Are CFDs Traded On Currencies
Currencies are traded directly through cash investments in different currency accounts, along with investment in the forex markets, which is usually highly leveraged in its own right. Another way in which currencies can be invested in is through CFDs, which use currency pairings as an index in order to allow the trade to take place. Generally speaking, CFDs track similarly the underlying forex markets, adjusted for other factors that the broker feels are relevant, but are crucially subject to only one tax regime and denoted in only your base currency. The advantages of trading forex through CFDs rather than directly are largely practical in nature, versus the more tangible financial advantages of trading in CFDs for certain other classes of investment. That’s not to suggest the practical differences are any less important, however – the ability to trade in a single currency, under a single regime, but with the same types of flexibility and leverage as standard with direct forex investments makes CFDs an attractive option for many traders. Particularly for those that have CFD accounts already, the ability to simply trade on foreign currencies through the same account is advantage enough to make CFDs a viable alternative means of trading on international currencies.
CFDs vs Forex
CFDs provide several advantages over trading currencies directly, but the main technical differences lie in ownership. In trading CFDs, you don’t actually own any currencies – only contracts relevant to the indexed price of the currencies on which you are trading. That means you can circumvent problems associated with different tax treatments, differing current exchange rates and different legislative frameworks as opposed to buying in currencies directly. This is all possible with equally significant leverage, and equally minimal trading costs to ensure trading is as financial efficient as possible.
Choosing whether you’re best to trade in currencies directly or through CFDs depends specifically on what you’re looking to achieve, and if you have particular investment requirements it may be advisable to consult a professional adviser on which way would make most financial sense for you. As a general speculator, trading through CFDs is unlikely to cause you substantial difficulties over trading in forex directly, and for simplicity’s sake trading through a single account is arguably more straightforward.