Rather than physically buying or selling one currency for another, when you take a position on forex with a CFD you’re making an agreement to exchange the difference in price of a currency pair from when you open your trade to when you close it.

Forex CFD prices are based on the underlying market, with the provider’s spread wrapped around them. These prices are displayed in the same format you’d see in the window of a forex exchange, eg 1.278657.

Standard forex CFD contracts are worth 100,000 units of the first named currency in the pair, while mini forex contracts are worth 10,000 units.

Price sourcing

One major thing to note when trading CFDs on forex is where your provider gets their prices from.

Because forex is an over-the-counter (OTC) market, there’s no central exchange for trading. Therefore, there are no standardised rates for forex transactions and no official values that CFD providers can use for their own prices.

Instead, providers generally source prices from one of the major forex-trading banks (eg Barclays, Deutsche Bank, JPMorgan, UBS). Some even source them from a number of different banks, choosing the best buy and sell quotes from among them. The more banks that are used by your provider, the more competitive their forex prices are likely to be.

Forex spreads

Once your provider has the underlying rate, they will then add a spread on top to create their own prices. This spread is usually variable – mainly because the spread between the buy and sell prices in the underlying market is also variable – and so is liable to change throughout the trading day based on the volatility and liquidity of the underlying market.

For this reason, when advertising their forex prices, providers will often refer to a number of different terms, for example:

• Minimum spread - the tightest possible spread a provider will offer
• Typical spread - the standard dealing spread, used most of the time
• Average spread - the average spread over a given period of time
• Fixed spread - a spread that will not vary, usually applied over a specified period of time
• Capped spread - a spread that will vary, but only up to a predefined maximum

To keep things as simple as possible, most providers will generally only use two or three of the above. Here's how IG Bank presents its forex spreads for some of the major pairs:

It’s important to understand that the spread could get wider than the quoted typical spread in certain market conditions. If a forex pair is particularly liquid and unlikely to experience wild price swings, a provider will usually only add a small spread. As the market gets less liquid and more volatile, the spread tends to get wider.

When placing a trade, you’ll want to find the tightest possible spread, because the tighter the spread, the less the market will have to move in your favour in order for your trade to become profitable. So it’s important to consider when and in what conditions to enter and exit your positions on currency pairs, as wider spreads could have a significant effect on the profitability of your trades.

Impact of leverage

When you trade CFDs on forex, you’ll need to put up a margin payment which may only be a small proportion of the value of the currency you’re dealing on. Remember that your potential loss could be much greater than this, however.