Contracts for difference (CFD) and binary options are some of the most popular trading instruments available to online traders.This article will show you the difference and similarities between CFDs and binary options, so you can determine the most appropriate instruments for your trading needs.
What Is the Difference between CFD and Binary Options?
A CFD is also known as a contract for difference. This is a contract between the trader and the broker to exchange the difference between the entry price and the exit price of an underlying asset.
In this case, the broker is the seller and the trader is the buyer. The broker therefore sells to the trader the difference made between the opening price and the closing price of an underlying asset.
The trader (you) will pay the broker if the difference between the opening and closing price of the underlying market is negative.
Just like binary options, traders use CFDs to predict the future price movement of underlying assets, without the need to own the underlying assets. You can go short i.e. sell your contract so you can earn profits from falling prices. Alternatively, you can go long to profit from rising prices. You can also hedge your assets portfolio to balance off any potential losses in the value of the underlying asset.
Differences between CFDs and Binary Options
Although CFDs and binary options bear some similarities, these two trading instruments are also markedly different. The major differences include:
Level of risk
In binary options trading, the trader is usually aware of the potential loss or profit they will incur depending on the price movement of the underlying asset. However, with CFD trading, it is not possible to determine in advance, what you stand to gain or lose with the fluctuation of market prices. This is because CFD trading entails trading on the difference between the entry and exit prices of the underlying asset.
Advanced traders can earn more returns trading CFDs. However, the level of risk in CFD trading is considerably higher than trading binary options.
CFD trading, unlike binary options trading involves paying commissions and fees for each trade you undertake. This is because CFDs are financed with borrowed money so traders are able to trade numerous underlying assets at a small price. Each broker has their own fee and commissions structure.
When it comes to binary options trading, traders are not required to pay additional fees or commissions other than the initial investment. No fees are payable even if the trade ends out of money i.e. even if you lose. In fact, many binary options brokers offer a rebate of between 10-15% on out of the money trades.
Instead of rebates, CFD traders are allowed to hedge against losses by applying their own stop losses. But stop losses can only be applied when losses are already imminent.
Range of tradable underlying assets
Trading CFD offers you access to a much wider pool of bases including bonds, forex, indices etc. On the contrary, binary options trading requires the existence of an underlying asset—this mean forex and index cannot be traded using binary options. If you are looking to access more bases for trading, CFDs offer a better option.
Similarities Between CFDs and Binary Options
CFDs and binary options are similar in the following ways:
They are derivatives – You do not have to own the underlying asset to trade on the asset.
They have short trading periods – For both binary options and CFDs, traders can select trading periods as short as one hour to a week depending on your trading goals.
Price movement prediction – Both trading instruments entail making predictions about market prices of underlying assets.
While both CFD and binary options trading bear considerable risk, CFDs are invariably riskier with potentially high returns. CFDs are also more appropriate trading instruments for advanced or professional binary options traders.