What forex trading and CFDs are

A pair of currencies

A forex trader generally takes a position on two currencies at once, known as a currency pair. Moneysmart’s example is AUD/USD, the value of the Australian dollar in US dollars.

ASIC’s product intervention order sorts pairs into two kinds, because it sets a different minimum margin for each. It defines an exchange rate for a major currency pair as a rate between any two of these seven currencies:

• Australian dollar
• British pound
• Canadian dollar
• euro
• Japanese yen
• Swiss franc
• US dollar.

Any other pair is a minor currency pair. Whichever the pair, Moneysmart says exchange rates can be very volatile and tend to move a lot in very short periods, and that even the most experienced traders have trouble predicting them.

A contract, not the currency

A CFD is a derivative, so its value comes from an underlying asset. Moneysmart’s list of possible underlyings is shares, commodities, currencies, crypto assets and market indices. The trader does not own that asset: they enter a contract with a provider and take a view on whether its price will rise or fall. ASIC’s Regulatory Guide 227 treats margin forex as economically equivalent to a CFD, with currencies as the underlying.

In Australia, Moneysmart says, CFDs are traded only over the counter and never on a licensed exchange, so each one is a contract between the trader and the issuer. RG 227 spells out what follows. No exchange or clearing house guarantees an over-the-counter CFD trade, so the investor carries the risk that the issuer does not meet some or all of its obligations, such as processing trades or paying out profits.

Leverage, in one example

CFDs use leverage: the trader pays a small amount, called margin, to take a larger position. Gains and losses are worked out on the full value of the position rather than the margin, which is why a small change in the underlying’s price can have a big effect on what the CFD is worth.

On its forex page, Moneysmart adds that when the market moves against a leveraged position, the provider may ask for more money at short notice or close the position automatically. For retail clients, losses can quickly grow past the margin that opened a position, although ASIC’s product intervention measures cap them at the money held in the client’s CFD trading account. That cap, and the close-out rule that sits beside it, are set out in the protections on a retail CFD account.

What it costs

Moneysmart names the costs of forex trading as spreads, commissions and financing costs, and warns that they add up. For CFDs it lists commissions, spreads and overnight financing fees, and says these can be high. A stop loss order can limit losses, though a trader may pay a premium to have one guaranteed.

There is also the risk of not being able to trade at the moment a trader wants to, which Moneysmart puts down to thin liquidity in the market, execution risk, or problems with computer systems.

What the regulators found

Moneysmart describes CFDs as high-risk, complex and costly, and says most people who trade them lose money. According to ASIC research, at least 68% of retail investors who traded CFDs in 2023-24 lost money, and Moneysmart notes that most people who start trading CFDs stop within a year.

For leveraged forex in particular, Moneysmart says most retail investors find it difficult to make money over the long term, and that frequent trades, leverage, fees and fast-moving exchange rates can add up to significant losses. ASIC’s own reviews of 2017, 2019 and 2020 found that most retail clients trading CFDs lose money, and its product intervention order followed in 2021. The guide to the leverage limits covers that order.

Another way to follow a currency

Under ways to trade forex, Moneysmart also describes a currency ETF, where an investor buys units in an exchange-traded fund that tracks a currency. Moneysmart’s note for any forex product is that different products carry different risks, and that the product disclosure statement (PDS) is the document to read carefully before investing.

Back to the minimum margins on the home page, or on to why being a retail client matters.