Nowadays, two hot topics in the online trading arena are foreign currency and cryptocurrency. Although both contain the word ‘currency,’ they are actually quite different. On the forex market, traders try to take advantage of changes in the exchange rates of different national currencies relative to others. Using a trading platform available on a smartphone or desktop computer, a forex trader will open deals based on his research about when the relationship between two currencies is about to change. For instance, if his reading leads him to believe that an impending interest rate hike by the US Federal Reserve will bolster the dollar against the Japanese yen, he may open a “buy” deal on the USD/JPY currency pair for a certain period of time. If the dollar does strengthen against the yen in that period, his deal will be successful.
In the world of CFD (Contract for Difference) trading, it’s possible to trade on the price movements of various kinds of financial instruments without actually owning the underlying asset, as CFDs allow traders to speculate about surges or dips in share, commodity, and crypto prices over specific periods of time. As both crypto and forex are offered on CFD trading platforms, how do they differ? Let’s take a closer look.
Traditional forex trading is done with fiat currencies like the US dollar or the euro, which are issued by national governments and backed by their credit. In America, the Federal Reserve generates money for the economy and the web of financial transactions in the country relies, ultimately, on the Fed’s backing. The business of forex trading consists in looking over employment reports, GDP reports, inflation data, and central bank monetary policy to ascertain when one currency is due to appreciate against another, and then opening a trade to capitalize on that conviction. Keeping abreast of monetary policy is important because governments actively exercise control over the values of their currencies. Other factors can affect currency pairs too, for instance geopolitical events or periods of risk-off sentiment in the financial markets.
Digital currency, also known as cryptocurrency, is not issued by any central authority, but, in theory, could be produced by anyone with the requisite machinery. Crypto’s existence is based on a big, decentralized computer network over which no authority holds sway. It exists on the blockchain, which is an online public ledger that records transactions immutably. Crypto has special talents as a form of payment, for instance reduced transaction times and fees that result from cutting out the middle men (payment providers). It can also be programmed to pay only at such time that certain conditions are met, which is called a smart contract.
There’s a relation between cryptos’ special features, like these, and a specific crypto’s prices. For example, prices of the crypto Ether were supported in the first months of 2022 by expectations of a large-scale improvement in the Ethereum network, through which it would transform from a proof-of-work system to one that works by proof-of-stake. Aside from utility, crypto prices are affected by the news. When celebrities publicize their optimism about a cryptocurrency, its price may surge as a result. Or, if news of crypto criminal activity is reported, this may sap confidence in crypto as a whole. Supply and demand drives prices, but crypto is generated through “mining”, and when motivation to mine is low (due to, say, low Bitcoin prices), smaller-scale miners may produce less, thus affecting crypto prices.
One reason crypto trading attracts people is the fact that crypto prices have tended to skyrocket in very short periods of time, making for a unique trading opportunity. Bear in mind, though, that the volatility of cryptocurrencies can also work against you, as they can lose huge amounts of value in very brief periods too. For a CFD trader, this doesn’t necessarily have to be a drawback, since he could open a “sell” deal on any given cryptocurrency, whether it be Bitcoin or Ripple or Polkadot, in the expectation that prices will slip.
They key factor to remember, whether you are trading forex or crypto as CFDs, is to develop a solid trading strategy based on substantial research, and to set risk management methods like stop-loss in place to make sure that, if prices go against you, your losses could be cut to a minimum. Also, especially if you are a less experienced trader, it is best to limit your trades to small amounts until you gain more experience. In 2022, one of the most important factors driving crypto prices has been the risk-off sentiment engendered by higher interest rates and the Ukraine conflict. Since cryptos are widely regarded as risky assets, their prices have suffered as a result of the new economic climate. Therefore, regardless of what you decide to trade, keep an eye on Fed monetary policy in the weeks coming up, as well as geopolitical news bulletins in order to make more informed trading decisions.