cfd trading

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What is CFD?

A Contract for Difference (CFD) is a traditional product that represents an underlying asset. When trading CFDs, you are contracting to buy (or sell) on margin, and you collect the difference (or payment) when you close the position. Unlike buying a stock or futures contract, a CFD is a derivative, which means you do not actually own the underlying asset during the transaction. CFDs can be made to mirror almost any financial instrument or market, including individual equities, indices, currency pairs, interest rate products or bonds. If it moves, and there is demand, you can be sure there will be a CFD for it.

CFDs are generally not recommended for new traders. If you read the above paragraph and Google needed some of the words used, you most likely do not trade CFDs yet. A solid understanding or the complexity of leverage, margin, counterparty risk and derivative products is recommended. As a rule, you should only trade what you are prepared to lose, as CFDs are volatile and you may be liable for additional losses. Set up a demo account and experiment, but make sure you do your research, understand the product and its insurance before you deposit real money into the account.

How do you trade CFDs?

Buying, selling or trading a CFD works in the same way as futures or forex, except with a CFD you do not actually own the underlying instrument. When you are trading there is a difference in value between when you first enter the trade and when you exit it. Hence the name, the difference to contract. Most CFD providers also require that you cross the spread to enter or exit a position. Let’s go through a business example for some clarity:

You want to buy 100 “shares” in Company XYZ, which you believe is going to increase in price in the short term.

The current price is $10.55, the bid is $10.50 and the offer is $10.60.

• You click BUY, cross the spread, and pay $10.60 for 100 “shares”.
• You used $53 of margin on your position (assuming margin of 5%) instead of the $1050 + fee you would outlay if you bought the stock yourself.
• The stock quickly moves to your target of $11, where you decide to sell.
• You click SELL, passing the spread, and are loaded with $10.95 on your 100 “shares”.

Congratulations! You made a profit of $35 (35c per “share” x 100) on your position.

As you can see, leverage is powerful. A $35 profit on $53 margin (66%) is a far higher ROI than the 4-5% profit you would get buying the underlying, even if the total dollar volume is slightly lower.

Herein lies the charm of leverage and CFDs. Of course, the opposite is also possible. An equivalent move could wipe your CFD account of its capital (and more).

Why trade CFDs?

Because CFDs are leveraged products, they offer significant gains and losses over regular stocks or futures.

Pros:

• Speculation: Due to margin, CFDs are commonly used by traders to spot short term or intraday moves. Depending on the broker’s margin requirements and fee structure, holding them overnight can be very costly.
• Leverage: The amount of leverage available varies from broker to broker depending on the product and the market. The biggest advantage is the potential ROI a trader can obtain using CFDs compared to common stocks. As illustrated in the example above, you can easily make 50%+ ROI on your margin used, which can be very attractive to speculators who are comfortable with risk.
• Margin: CFD brokers only require between 2% and 20% margin on your position depending on the instrument and volatility. Like forex, it allows you to trade larger sizes than you would otherwise be able to, or gives you access to expensive stocks that you might not be able to trade. For example, if you want to buy 100 shares in Apple at $145, you will need $14,500 in your equity account, plus commissions. With a CFD broker, you may be able to trade the equivalent of 100 shares on margin of $725, or 10 shares at $72.50. It opens up new markets and opportunities.
• Exposure to global markets: Most CFD providers offer a huge variety of markets. You can trade the German DAX just as easily as you can an Australian Equity. All of this can be done on one account, without the need for expensive data or execution fees.
• Fees: Trading fees can add up very quickly, especially using retail brokers. There are no fees on CFDs, only the spread (which represents its own challenge).
• Hedging: CFDs provide an opportunity for those with equity portfolios to hedge their long equity positions quickly and cheaply. Options can be difficult and difficult, especially if you are using them to hedge positions. CFDs offer the savvy trader an inexpensive option and a variety of hedging opportunities.

Opposition:

• Leverage: This is a double edged sword. While buying the equivalent of 100 shares of Apple is much cheaper than using a CFD, you are exposing yourself to significant risk by doing so. A small move in the underlying can wipe out the value of your position or more, leaving you in the red with your broker.
• Crossing the Spread: Entering or exiting a CFD position requires you to cross the spread. There is no limit order. This means that you are always paying a premium to enter or exit a position. This is the price paid for access to margin. While this may seem insignificant, paying the spread can add up to a substantial amount of money, especially if you are an active trader. This makes it very difficult to execute some strategies (such as scalping).
• Betting Against Your Broker: A CFD is a contract with your broker. If you lose, they profit. This opens up several conflict of interest questions. It is very important to research your broker, check if they are regulated (many are not), and read online reviews. Contact them directly if you have questions before depositing any money into the account.

counterparty risk

Trade CFDs when contracting with your broker about the future movement of a financial instrument. Unlike an underlying trade, the counter-party to your trade is your broker. As you can imagine, this poses a host of conflict of interest issues, and regulators try to find an acceptable balance between protecting customers from predatory practices and allowing traders to trade as they wish. And the effort has continued.

Skeptics may argue that trading CFDs with your broker is like gambling in a casino. It is in the casino’s best interest that you are a happy, smiling customer… so they can ultimately charge you as much money as they want.

Theists will argue that it is in the CFD broker’s interest to obtain longevity from clients, and that they make enough money from spreads and volume that there is no incentive for their clients to do wrong. Shady practices will be reported to regulators, which will ultimately hurt their business and profitability.

The takeaway is that traders need to do their research on CFD brokers and regulation in their country. A good place to start is our list of recommended brokers.

how to compare brokers

spread / commission

1. Leverage and Margin Requirements
2. trading platform
3. Deposit and Withdrawal Options
4. additional features
5. regulation
6. mobile app

We cover each section in detail below.

spread or commissioned

The spread or commission affects every trader and every trade. This represents the ‘cost’ of making the trade. That is why it is important to compare one broker with another. Direct comparison may not be easy though. The spread will differ between assets, and may even change from day to day if the asset is volatile. So a broker may have the smallest spreads for forex pairs, but the largest for indices – and the figures may change the next day.

Depending on the asset, a broker may be the cheapest option – or the most expensive. So when comparing brokers and spreads, make sure you check the spreads on the assets you will be trading the most.

leverage and margin

Margin represents the funds a trader must deposit (and commit) to open a position. Only £50 may be needed to open a £1,000 trade on the GBP/USD currency pair. However that trade exposed the trader to £1,000 worth of risk (the risk of losing the entire investment is very small, but it is the value of the position) – hence the caveat associated with CFD trading “Loss may exceed your initial deposit”. Margin is also known as ‘leverage’. Where this is the case, leverage is often depicted in terms of multiples – so 200:1 would indicate leverage of 200 times the deposit. Equivalent Margin 0.5%. So when comparing brokers, lower margin requires smaller deposits. This will be significant for some traders, but less so for others.

trading platform

The trading platforms can be considered broadly similar. This can be a mistake if a trader finds a particular platform difficult to use. Yes, most platforms will have similar functions – but the usability and look and feel may differ – and some will not suit every trader.

It is important to trade on software that is familiar and easy to use. Traders may miss prices, or worse, make trading mistakes, because the trading platform did not suit them for whatever reason. The trading buttons may be too obvious for some users, but if you are the trader who accidentally entered a large trade, you may wish you had based a broker choice on the clarity of the platform. All brands listed here offer demo accounts – try before you buy.

Deposit and Withdrawal Options

This is becoming less important as more and more payment methods are added by brokers – but if you ever have problems making payments or receiving funds from a broker because they have a restricted list of withdrawal methods – you should Would know how important it can be check first.

Features (Charts, Technical Analysis, Research)

If you plan to research your trades through your broker or their software, you want to make sure you have the best research tools available. Charting standards vary greatly. Some brokers (notably ETX Capital) offer the best charting facilities, with a range of technical analysis tools that will satisfy even the most ardent technical analysis expert. However, some brokers either do not research their traders, or do it elsewhere. Their equipment lags behind some rivals. Then again, take a look through a demo account and see if the broker is the standard you need.

other factors

Other factors that enable new traders to compare CFD brokers may include the quality and availability of mobile trading applications. As always, trading on the move will be important to many traders – others will be happy not having to use a mobile app.

Regulation should be an important parameter for any broker. Only regulated CFD brokers are included on these pages. It is less of a comparison factor than a prerequisite.

Bonuses can sometimes sway a trader. Terms and conditions are always important with any bonus deal. They can often lead to a new customer to do business with. However, where used correctly, a bonus can mean more funds to trade with, or a couple of risk free trades – so they can be useful. Just remember that a short term bonus is not going to make up for the expensive spread in the long run.

Our review covers all the factors needed to compare CFD brokers, and as mentioned earlier, all CFD brokers listed on our pages offer demo accounts. Therefore traders can take their time, read detailed reviews, and try out the platform themselves before making a choice. Once you have all the information, you can decide the best CFD broker for you.

Find the Best CFD Brokers

Use these steps to make an informed decision about the best broker for you and your unique investment style;

• Consider your own trading style. For example, how many assets do you trade, how often? How big is each trade, what is your overall trading objective etc.
• Shortcut cfd brokers to suit your trading style and strategy
• Take advantage of demo accounts. Compare each trading platform you choose.
• Get used to and trade on each platform – then make the best choice for you.
• Deposit real money, and trade

Remember: traders can use any number of broker accounts, and use those with the best terms for specific trades or assets. Trade gold with one firm, but US stocks with another. Use whatever account offers you the best deal for that particular trade.