What to Consider When Choosing the Best CFD Broker and Trading Platform
Anyone can trade CFDs even with a deposit of as little as 500 USD. However, in order to practice a healthy and safe risk management, a larger deposit is generally recommended. CFDs (Contracts for difference) have become the world’s most traded financial instruments – and in the shortest period of time too! A CFD is nothing more than a bet on what the price of a certain commodity, such as a stock, foreign currency, or commodity will be after a certain period of time. This is a contract usually between an individual and a broker using a convenient online platform that normally also provide other instruments apart from CFDs.
When choosing a CFD broker, it is important to consider various factors including regulation, instruments available, reputation and many more factors which we discuss in this article.
What is CFD Trading?
A CFD is an agreement to pay the difference in the value of a particular underlying asset after the period of the contract expires. The underlying asset can be some company’s stock, foreign exchange, market index among other commodities. The actual underlying is never owned by the buyer or the seller. The profit (or loss) will be the difference in the price from when the contract was opened and the time it closed. There is no restriction on the time one has to hold the contract. It can be sold at any time the buyer deems fit. The broker offers a lot of leverage; sometimes as high as 1:500 or more. This allows for a lot of potential to make a bigger profit (or bigger loss) with a smaller budget.
If a share is trading at a price of USD 25.26 and a trader buys one hundred shares at the current price, the total transaction will cost the trader USD 2,526. If the broker were allowing the trader a margin of 50% (also called leverage), the trader would have to put down half the amount for the trade. Now, if the trader were trading CFDs, the margin required would only be 5%. Therefore, this trade would only have required USD 126.30.
The majority of CFD brokers make their profits through what is called the spread. This is a small difference in the buying and selling price of the CFD. When a trader enters a CFD trade, the online account will immediately show a loss equal to the size of the spread. Therefore, if the broker charges a spread of 10 cents, the trade will immediately show a loss of 10 cents when the trade is opened. The share will have to appreciate by 10 cents to break even and any appreciation after that will be pure profit.
As long as the trader holds the stock and the price continues to increase and reaches a price of 25.76 USD the 100 stocks can be sold for a profit of USD 50 within a matter of a few days if not hours – and all for a small deposit of USD 126.30 instead of USD 2526!
The fact that the CFD brokers offer so much leverage, allowing traders to trade huge amounts of stock with a relatively small amount of money, make CFDs a much sought-after business.
Advantages of CFD trading
Higher Leverage Lower outlay
One of the advantages of CFD trading is higher leverage. However, this could also be detrimental to the trader if the trade goes bad.
Unlike traditional trading, CFD brokers provide much higher leverage to their clients. Two percent is the standard margin required for CFD trading. However, depending on the type of the underlying of a CFD, the margin required to place a trade can go up as high as 20 percent. A higher margin requirement means that more capital must be traded by the trader and a lot of potential gains – and increased potential risks as well.
Access Global Markets With CFDs
CFD brokers offer access to all major world markets and it does not matter in which country the trader is residing. By using the broker’s online trading platform, the trader can open and close trades as long as the market he or she is trading is open. Depositing and withdrawing money can also be done as easily as making trades. Deposits are facilitated through debit and credit cards as well as through bank transfers. Withdrawals are done the same way.
Go Short or Long With CFDs
When a trader buys a contract, it is said that the trader is “going long”. This means that the trader is hoping to make money by selling the share if the price of the share increases. On the other hand, if the trader expects the price of the underlying of the CFD to decrease, he or she may choose to open a trade by selling a CFD – even if they do not own the CFD! This is referred to as “going short”.
Let us say for instance a trader expected the price of a share to fall by ten percent and the share was currently trading at USD 100. The trader would immediately place a sell order on the market and sell the share for USD 100. The price of the share would fall by the predicted 10% and the trader would buy back the share for USD 90 and make a profit of USD 10.
Some markets have rules that require the trader to borrow the instrument before going short. However, with CFD trading, this is not a prerequisite in most cases.
Choosing a CFD Broker
There are CFD brokers out there in places no one ever heard of. They all have web sites but don’t go by what is displayed on the site. Look for their Regulator registration number and check with the regulator. You will get to know of all complaints filed against the broker and any fines imposed too. Choosing a CFD broker is something that must be done with a great deal of caution.
So, how can you sift the good from the bad and then settle for the best?
Is the Broker Regulated?
At the very outset, while choosing a CFD broker, one must determine if the broker is regulated. A regulated broker will display the registration number on the website.
Various countries have regulators that keep an eagle eye on all financial instrument brokers. The broker is required to deposit millions of dollars with the regulator, who ensures that the broker runs the business in accordance with the laws and regulations. It is very easy for amateur traders to be fooled by authoritative terminology and legal language. However, the regulators such as the Financial Conduct Authority in the UK and the FSA in the US ensure that brokers work within the framework they have set up. This ensures the safety of trader’s money making the playing field safer.
Dealing Desk or No Dealing Desk
If the broker you are considering is trading tour orders through a dealing desk, there is every possibility that the broker is manipulating the CFD prices. A non-dealing desk broker allows his traders to trade directly on a common network. This allows for transparency and traders can trade at prices every trader is trading at.
A straight through process (STP) or an ECN (Electronic Currency Network) is another guarantee that the broker is not manipulating the trades. One way to tell if the broker is not trading through a dealing desk is to note whether or not the broker is charging a spread or a commission.