The Forex market is a vast entity where traders meet and speculate on the future movement of a currency or currency pair. Despite the general belief, most of the market participants aren’t retail traders.
In fact, the retail traders represent only a small fraction of all the parties that buy or sell in this environment. More precisely, a single-digit fraction!
It is said that out of the total of five trillion dollars that change hands every day on the Forex market, only about six or so percent of it belongs to the retail traders. Coupling that info with the fact that trading is over eighty percent automated these days and you’ll have an idea about who’s responsible for the sudden spikes and dips in the Forex market.
When the prices move during the NFP (Non-Farm Payrolls) release in a fraction of a second, that’s not human trading. That’s not the retail trader, the average Joe.
Instead, the other market participants are responsible for such reactions. Forex brokers from all over the world, for example from the United Kingdom or other parts, actively participate in the Forex market.
Depending on the brokerage house model, the broker decides to keep some or all their retail traders’ orders in-house. Brokers set up a trading department to deal with their customers’ orders.
Liquidity providers, commercial banks, and even central banks actively participate in the currency market. Not to mention consortium of banks that deal with the funding of a merger and so, as they need to exchange vast sums of money.
All these actors contribute to the market’s volatility. It is because of them the currency market moves so fast, not because of the trading coming from retail traders.
Introducing CFD Trading
Facing stiff competition, Forex brokers realized they’d survive only by offering new products to the retail trader. Because of the factors explained above, Forex brokers struggle to retain customers from the smallest customer pool in the market: the retail trader.
Therefore, the competition is ruthless. Brokers realized they need to stay up-to-date with all the new technologies (it is because of that that today ECN – Electronic Communication Network and STP – Straight Through Protocol exists) and to offer new ways to retain the retail clients. And, of course, to find some new ones.
One way to accomplish the tasks is to offer new products to trade. To expand the product offering.
As such, a CFD or a Contract for Difference appeared. Trading such a contract is super easy for the Forex trader, as it is similar to buying or selling a currency pair.
No ownership is involved whatsoever; all traders need to do is to correctly indicate the direction and gain the respective difference if the market moves in their favor. If not, they’ll mark a loss.
Because of CFD’s, traders have access to markets otherwise difficult to access. All commodities in a Forex account are subject to CFD trading. Gold, silver, oil, and even stock indexes represent CFDs.
Moreover, individual stocks (typically a Forex broker will list here the shares of a well-known stock, like Apple, etc.) trade under the CFD’s rules. In other words, everything that appears in a Forex trading account, other than the currency pairs, are CFD’s.
For diversification reasons, CFD’s are a great way to hedge a trading account or to split the risk. Moreover, they offer the Forex traders the possibility to access different markets without the need to open an account with another entity: stockbroker, commodity broker, etc.
It comes handy to have various markets to analyze, as many of them are inter-related with the Forex market. For example, everyone knows the Canadian Dollar, and the oil price enjoy a direct relationship, that gold and the Australian Dollar move in tandem and that JPY pairs and the U.S. stock indexes travel together too.
Having the possibility to access them all from the same trading account, is a significant opportunity. All these, thanks to CFD trading.