A lot of interest has recently been generated in alternative trading vehicles to the ever-popular binary options. This is largely due to a rise in the general proficiency of most retail traders, having learned to trade binary options more or less successfully, many of them are now looking for other challenges where they can profitably employ the dualistic approach to the markets engendered by binary trading.
At first glance CFD (or contract for difference) trading may seem like a match made in heaven for these battle hardened binary options veterans. And indeed there are many similarities between the two investment vehicles, but also a few marked differences that need to be taken into account before investing in CFD positions. To this end we created this brief guide, to give binary traders seeking to broaden their trading repertoire a basic breakdown of the differences between binary options and CFD trades.
Firstly both of these instruments differ from standard currency, commodity, stock and index trading in that they are derivatives. This means that there is no real connection between the trader and the asset being traded. In other words investing in a gold position in both binary options and CFD trading does not, at any point in the transaction, involve a purchase of a quantity of physical gold.
In the case of a CFD trade (and much like binary options) a contract is bought that gives a trader the opportunity to speculate either a future rise in value of a given asset, or a future drop in value, both positions can yield profits to the CFD investor as they can for the trader of binaries due to the investor not taking physical possession of the asset in question (and thus being necessarily invested in it rising in value. In CFD trading an upward forecast is known as going long and a downward forecast in known as going short. In binaries these two vectors are represented by Call and Put trades, respectively.
One of the differences between the two instruments is that in binaries the trader is aware before the trade is ever locked in what the earnings of a potentially successful trade will be and what the losses for an unsuccessful trade will be. This is because in binary options trading the risk is precalculated and preset. In CFDs however the matter is a little more complicated, due to a CFD trader essentially trading on the difference between the asset price at entry and exit there is no way to know how much they stand to gain, or indeed how much they stand to lose. This is obviously due to the fact that there is no way of knowing just how drastic the price action will be.
Another pronounced difference between the two methods of trading is that CFD traders have to pay fees and commissions on their trades. This is due to CFD trades being heavily leverages, enabling CFD traders to get into all sorts of markets are a fraction of the ordinary cost. The leverage amounts are thus subject to fees and commissions that vary from broker to broker. Binary traders have no such commitments. All they need to worry about in any given binary trade is how much they are willing to invest in the position. Also leverage leaves CFD traders open to losses that exceed the initial amount if the price action moves sufficiently in the opposite direction to their predictions. Binary traders have no such worries, the losses they take in the event of an unsuccessful trade never exceed the initial investment amount, and many brokers offer small rebates on losing trades, again this amount varies between brokerages but the industry standard is between 10-15% of the initial investment amount. CFD traders do not have such luxuries, as we have mentioned elsewhere dollar for dollar CFD trades have the potential to be far more profitable than binary trades although binary traders are in fact much safer options, in CFD trading there are no rebates, and CFD traders must set their own stop losses, which can only be applied when a trader is already losing so some hit, however small has to be taken. The only fees that binary traders have to contend with are fees for withdrawing their profits, these too vary from broker to broker with repeated withdrawals tending to be the most costly for binary traders.
The similarities between the two investments are of course the binary nature of the trade, the fact that both can take advantage of bear markets and the sheer amount of assets available to both binary and CFD traders. These two markets are by far the most liquid and have the greatest number of investment opportunities in terms of asset numbers across all four main asset classes (stocks, indices, currencies and commodities.
Generally speaking CFD trading is far better suited to more proficient investors with a greater degree of market experience and a higher amount of disposable risk capital. Binaries are better for entry level investors testing the waters with a limited amount of capital they are willing to risk.
George Milios is the founder of onlineforextrading.net, the binary options and forex news portal which is dedicated to providing you with all the information you need to successfully trade.