💶 Compare Best Financial Markets Brokers
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📉 What is CFD
A contract for difference (CFD) is a type of financial instrument that tracks the price of an underlying asset or security. CFDs can be traded through online brokers and are available for a wide range of asset classes, including forex, shares, and cryptocurrencies. When a trader enters into a CFD trade, they are speculating on the price fluctuations of the underlying asset within a specific timeframe, without actually owning the asset itself.
Unlike when you purchase a company stock and become the owner of those actual shares, CFDs do not provide ownership of the underlying asset. Instead, a CFD is a contract between the trader and their broker, where the trader takes a long or short position on the price movement of the underlying asset.
CFD trades can be short-term or long-term, and the profit or loss is determined by the difference between the buy and sell prices. CFDs are popular among traders because they allow for both long and short positions, which means that traders can try to make a profit regardless of whether the market is rising or falling. However, CFDs are a leveraged product, which means that a relatively small outlay can result in a large contract. This can maximize profits if the trade is successful, but it also maximizes losses if the trade is unsuccessful.
Despite their popularity, CFD trading is considered risky, and as many as 8 in 10 investors lose money when trading CFDs. Therefore, it is essential to have a good understanding of CFD trading and the associated risks before entering into a trade.
⚖️ Differences between CFDs and Shares ✅
- Ownership: When you buy shares, you become a partial owner of the company, entitled to dividends and voting rights. In contrast, CFDs are financial derivatives that don't grant ownership of the underlying asset; they are contracts between traders and brokers.
- Leverage: CFDs offer the potential for higher leverage, allowing traders to control larger positions with a smaller initial investment. This can amplify both profits and losses. Shares typically have lower leverage, limited to the amount of capital invested.
- Cost: Trading CFDs often involves additional costs such as spreads, commissions, and overnight financing charges, making them potentially more expensive than traditional share trading.
- Short Selling: CFDs allow traders to profit from falling prices by selling assets they don't own (short selling). This is not directly possible with traditional shares, although some stock exchanges offer short-selling mechanisms with certain restrictions.
- Expiry: CFDs are time-limited contracts that expire on a specific date, while shares can be held indefinitely, as long as the company remains listed.
- Dividends: Shareholders are entitled to receive dividends when the company distributes profits, but CFD traders typically do not receive dividends as they don't own the underlying asset.
- Regulation: The regulation of CFDs and shares may vary depending on the jurisdiction, with CFDs often subject to more specific regulations due to their complex nature.
In conclusion, CFDs offer flexibility, higher leverage, and the ability to profit from both rising and falling markets, but they involve greater risk and costs compared to traditional share ownership. Deciding between CFDs and shares depends on individual risk tolerance, investment goals, and understanding of the underlying assets' characteristics.
🎖️ Best CFD Platform Brokers
After thoroughly testing the top forex brokers in the industry, our research team has meticulously evaluated over 60 of them (you can learn more about our testing process). As a result, we have compiled a list of the best forex brokers for trading CFDs, which includes:
- IQ Options
🏆 Pros & Cons of CFD Trading
- A wide range of markets is available to CFD traders – including instruments that might not normally be available in your country of residence.
- When trading CFDs, you can go long or short; it’s fairly easy to open a short (sell) position.
- Most CFD trades are executed instantly, which means that there can be less risk of slippage (depending on your trading account and order type).
- Typically, CFD trading platforms have low trading fees and low commissions (relatively speaking).
- Trading with leverage from a margin account is risky; it’s possible to lose your entire balance while trading CFDs.
- CFD traders incur overnight fees when holding a position overnight (also known as carry charges).
- CFD traders own a contract – there’s no ownership of the asset itself. This means that CFD traders are also ineligible for benefits such a dividends and shareholder rights.
- CFD trades are subject to capital gains tax.
🎻 What Instruments Can You Trade with CFDs
CFDs offer a wide range of financial instruments that can be traded. Here is a list of various financial products that you can trade as CFDs:
- Stocks (e.g. Facebook, Barclays, Vodafone, Tesla)
- Cryptocurrencies (e.g. Bitcoin, Ripple, Ethereum)
- Commodities (e.g. Gold, silver & oil)
💸 Are there any specific fees associated with trading CFDs?
Generally, when you buy or sell a Real share or a CFD, you can expect to encounter commissions, spreads, and currency conversion fees. In addition to these charges, there is something known as "overnight funding" when trading CFDs. This involves paying interest on the borrowed capital used for trading. For example, on eToro, the overnight finance rate for long positions is calculated at 6.4% + LIBOR per year. To illustrate, let's consider the following hypothetical scenario:
- Investment duration: 24 hours
- Investment amount: $2,000
- Share price: $250
- Number of shares: 8
- Overnight funding rate: (6.4% + LIBOR) / 365
The cost per day of holding the CFD in this case would be calculated as follows: ((0.064 + 0.0199) / 365) * 8 shares * $250 USD = $0.46 USD. It's important to note that this cost will fluctuate as the share price and LIBOR change over time.
🚨 Risks in CFD Trading
CFD trading, like any other form of trading, carries a certain level of risk. Some of the main risks associated with CFD trading include:
- Leverage: CFD trading allows traders to use leverage, which means that they can control large positions with relatively little capital. Leverage when CFD trading can amplify potential gains, but it can also amplify potential losses if the market moves against its position. Traders may end up owing more than their initial investment.
- Counterparty Risk: CFD trading involves entering into a contract with a broker. There is a risk that the broker will not be able to fulfil its obligations under the contract, which is known as counterparty risk. It's important to check the broker's financial stability and regulation before opening an account.
- Market Risk: The prices of financial instruments can be affected by a wide range of factors, including economic data, political events, and natural disasters. Traders can lose money if the market moves against their position.
- Stop-Loss Orders: Stop-loss orders are designed to limit potential losses by automatically closing a position when the price reaches a certain level. However, stop-loss orders are not guaranteed and may not execute at the desired price in fast-moving markets.
🕵️♂️ Key criteria for comparing cfd brokers
If you are considering trying out CFDs, then it’s strongly recommended you start off using one of the free demo accounts that are readily available. It’s safer to start off using virtual funds and it’s also hard to beat the hands-on experience. Clicking on the links to regulated brokers will take you to our overview of their Demo accounts where you’ll get a good idea of what they have to offer.
The trading experience is a key part of trading, but there are other factors to consider when establishing which is the best CFD trading platform for you.
- Education & learning— Whether you’re a novice who is just starting out, or an experienced trader looking to learn about a new market, the support material offered by your broker is crucial. The brokers that score most highly in this area offer materials in a range of formats including video and written formats.
- Research & analysis— When it comes to putting your money at stake, you’ll want to have a well-thought-out strategy. Some brokers offer more than others in terms of materials to help you identify trading opportunities. IG stands out because it offers a full range of trading ideas based on fundamental and technical The FP Markets ‘The Week Ahead’ videos, which are released on Sunday evenings, are also a valuable resource.
- Spreads, commissions & fees— Trading costs have been driven down in recent years. New technology and competition among brokers mean that traders can take positions in the markets at little expense. Even small costs can stack up and keeping an eye on the fees charged at your broker can help you squeeze out a better net return.
- Customer support— This can be measured in terms of quality and accessibility. Pepperstone provides a good benchmark. Its multiple award-winning customer support team is contactable by phone 24/5. Considering you might have a query on a live trading position, it’s crucial you feel happy with the level of support your broker offers.
- News services— There are a lot of free market news sources available. Brokers that offer their own bespoke service do provide something tailored to individual traders. The broker XTB offers free market audio as part of its service. IG has its own TV station-style broadcasts and FX Pro provides daily newsletters covering all sectors.
- Mobile trading— Good platforms now provide their clients with apps and browser-based platforms. Markets can be fast-moving, so any tools that help you keep track are to be welcomed.
- Client protection— This is one of the most important features of the selection process. It’s a good idea to stick with brokers who are regulated Tier-1 authorities, such as the Financial Conduct Authority (FCA), the Cyprus Securities and Exchange Commission (CySEC) and the Australian Securities and Investments Commission (ASIC).
👍 5 reasons to trade CFDs
- CFDs allow you to speculate on thousands of financial products and global markets that you may otherwise be unable to access.
- You can go long or short, hence you can profit (and also lose money) in both rising and falling markets.
- You can hedge your portfolio. Hedging acts as insurance for the rest of your portfolio through CFDs.
- You can usually access free demo accounts, as well as charts and trading tools through your broker.
- CFD contracts don't necessarily have a fixed expiry date, meaning you can close out your position when you decide.
🌟 Top tips on how to make a profit from trading CFDs
There are some general principles that apply, regardless of which broker you choose to use.
Have a clear strategy
- Broker platforms are a good place to find trading ideas based on technical and fundamental analysis.
- They also provide information on the different trading strategies such as scalping, momentum, break-outs and reversions.
CFD risk management
- Stop losses and take-profit orders are instructions built in to positions to ensure your losses are limited to a certain amount.
- They also ensure that you scale out of positions if they make a certain amount of profit.
Develop a trading mentality
- Successful trading requires the right mental approach.
- Be disciplined about putting on trades.
- ‘Boredom’ trades will eat their way through your account.
- Also, try to take the emotion out of trading and trade in sizes small enough to let you consider trading decisions objectively.
Learn from others
- Some brokers will allow you to take on the ideas of others.
- Copy trading involves you paying a fee for signals from another trader to be applied to your account.
- Social trading involves accessing online groups where ideas are shared.
Keep an eye on the economic calendar
- Markets can transform from one mood to another in an instant.
- Some of the triggers are known beforehand and monitoring upcoming announcements such as interest rate announcements can help you manage your positions.
Plan your day
- Be realistic about how much time you can offer up to CFD trading.
- Choosing types of strategies that fit in with your existing commitments is a good start.
Sit on your hands
- The old saying among professional investors is that some of the best trades you do are the ones you don’t do.
- There is nothing wrong with spending time out of the market and waiting for the optimal opportunity.
- Whether you are a novice or an experienced trader, it’s a good idea to keep your demo account running.
- That way, you can try new ideas out without risking capital.
📫 Final Thoughts
The best way to see if CFD trading is for you, or not, is to try it using a demo account. If you do well and graduate to live trading, then start off in small size to ensure you maintain the right approach.
Whether you make a profit will depend largely on your skillset and approach, but the CFD brokers mentioned can also help you with that. They all have a slightly different focus, so comparing them and doing live tests to find the best fit can pay off in terms of your trading bottom line.
Some Frequently Asked Questions.
However, the danger in CFDs trading arises when you place an order without fully understanding the implications. Using the previous example, you might mistakenly believe that your maximum exposure is $100, when in reality, it's just the 20% margin and not the full investment amount. With 5x leverage, your actual exposure would be $500 instead of only $100.
Hence, it's crucial to carefully examine all the details and potential risks before making any CFDs trades. Being well-informed can help you avoid potential pitfalls and make more educated decisions.