What does CFD trading actually mean?
A contract for difference (CFD) is a leveraged financial product that allows traders to speculate on an asset class without actually owning the underlying asset.
It is very important to highlight that CFD trading is not investing. It is very high risk speculation and it is possible to lose all your money fairly quickly.
Likewise, if you call the market correctly you can make a greater return on your money than by investing in fully paid up physical stock.
CFD trading also has the advantage of not being liable for stamp duty which is currently at 0.5% of the value of a trade.
Many short term speculators prefer CFDs to physical stock buying as the costs are lower, but if a CFD trader is using leverage then the risks are higher.
Where to find a CFD trading broker?
Use our comparison tables to compare CFD trading brokers. The key things to look at are costs, margin and the CFD trading platform. You can use the table to view the CFD broker websites and open demo accounts.
Three golden rules to sensible CFD trading
CFD brokers offer the facility for you to trade the financial markets, but only you can implement a winning strategy to make money trading. If you are looking for a CFD trading strategy these three golden rules are a good place to start.
1) Run your wins, cut your losses
This requires discipline and one of the main reasons that people lose money trading is because they are too eager to lock in a profit. trading CFDs is a numbers game and the best hedge fund managers in the world only get it right about half the time. That means that half of the trades they execute a loss.
The market is based on trend and reversion so technical analysis plays a high part in short and long-term CFD trading. If you call a trend right you are going to make money if you leave the trade open, if it a loser cut it straight away. You can do this by using a stop loss or a trailing stop loss.
2) Don't over trade
This is so important. If you only have £10,000 to play with you definitely don't want to put all that into one trade. Sure if it's a winner great but if it's a slow mover or a loss then you are stuck and won't be able to enter into any new positions when potentially profitable opportunities come up.
Plus, if there is a shock short-term overall market then you'll get a margin call and be forced to close your positions because you can't cover the variation margin. Being forced to close a position is one of the worst things that can happen to your trading strategy.
3) Diversify your positions.
One of the great things that CFD brokers provide the facility for is making money when the market goes down. This means that you can have a wide range of positions but actually remain fairly market neutral. For example, if you are short some individual stocks because you think they are badly managed then you are exposed to an upwards move in the markets. So you can hedge using a CFD position in the underlying index to protect against this. You could also have some long positions in similar sector stocks as some protection.
The key thing to remember is that profitable CFD traders don't open massive single positions and hope for the best.
Six Hidden Costs & Dangers of CFD Trading
If you are trading CFDs or spread betting on stocks here are six hidden costs and dangers that you probably haven't though about.
Trading OTC or “over the counter” products such as CFDs & spread betting will always be dangerous and especially risky if you are dealing on margin, where you can lose more than your initial deposit.
You should be aware of that fact as pretty much every financial promotion, website, account form and contract note will have a risk warning on it somewhere. Although according to the FCA's insight website we may all be suffering risk warning fatigue.
So, other than making or losing huge sums (relative to your initial margin) what other dangers lurk in the shark "invested" waters of ultra high-risk CFD trading?
I’ve put together a little list of things to watch out for. If you’ve anything to add please do so in the comments below. It all goes towards helping investors get the most out of their trading.
1. CFD Interest on overnight positions.
Just like when you borrow money from the bank, when you are trading a CFD you are borrowing to do so, and there is an interest rate attached.
A long time ago, when I opened my first CFD account I vividly remember the salesman saying, “well you get charged around 2.5% over/under base, but you shouldn’t really factor that into your trading”.
Hmmm, not LIBOR base, the firm’s base, which depending on the currency can currently be above 3%. So that’s 3%+2.5% or 5.5% on your positions size (depending on the first it will either be the initial position size of the daily, you need to check). So if you buy £100k of stock and hold it for a year that’s £5,500 in interest charges.
As with everything else in trading these rates are negotiable if your account is large enough.
2. CFD Commission or Spread Widening
There are generally two types of execution charges for trading CFDs. Either commission with clean prices, or no commission with a widened spread.
If you get charged commission it means you buy or sell at the actual bid/offer or insude if you are using a DMA (Direct Market Access) broker.
If you are being charged a spread then you won't get charged a commission, but you will be buying or selling at a price slightly wider than the bid/offer. So for example, if a stock is trading 101/102 your price maybe 100.9/102.1. The spread is usually widened inline with what the commission would be. In this case 10 basis points or 0.1%
You will agree to a commission rate when you open an account phrased either as “basis points” or as a percentage.
If you are spread betting you may find a broker who can offer you DMA on some smaller stocks by getting them to work an offer in the underlying market. But generally, you will be charged a widened spread.
If you are charged 0.1% commission that’s £100 on a £100,000 trade or 10 basis points. They are the same, just different terminology.
Normally, most brokers are quite clear about this, but it is worth checking you are not being charged double. If you have a high commission and don’t get market prices, it may be time to change your broker.
For larger traders paying commission and trading, DMA means you can trade inside the best bid/offer. The ability to get within the spread can often compensation for paying commission on wider prices.
This varies depending on broker, but when a share is suspended and you have a CFD position, most likely the risk department will raise the initial margin to 100% (or 99.99%) until the stock comes back.
The issue here is that you will have to fully capitalise the consideration, but you will still have a CFD position, so will be charged over/under CFD interest on something that is fully paid up.
Also, as a result your account may go overdrawn where you will probably be charged deficit interest.
This can be as high as 15%. So bear in mind that your running costs are now 15% plus 5.5% or 20.5% if your long/short rates are as above.
So this is one to avoid, or at least try and get confirmation from your broker prior to entering a trade that you can swap it into an equity position or they will waive the charges if a CFD position share is suspended.
You’ll be less likely to encounter this sort of problem if you stick to the large-cap stocks in the FTSE 350. But, if you are dealing with a decent broker, you should be able to talk to them and negotiate reduce rates under special circumstances.
4. CFD Dividend Payments
Normal practice is to pay 90% as they are taxed at source if you are long, but charge 100% if you are short.
However, as CFDs are OTC you are not the beneficial owner of the shares, your broker is (if they hedged the trade) so are not obliged to pay you the entitled dividend (usually on the ex-div date).
Check your broker's dividend rates, most are pretty good as it is just a cash adjustment and becoming a popular way to enter positions.
5. FX Currency Deficits on CFD P&L
Most CFD brokers these days will have your account in one currency and do automatic currency conversions into that currency when you have a different currency P&L.
But your broker may have a treasury cost to running a book in multiple currencies and will charge accordingly.
So, if you put £100k on your account and trade GBP stocks, but then buy $100k of US stock on 10% margin. You have a GBP but no USD. So you are essentially running a USD overdraft to fund the USD position. You may not have a margin call, because your GBP nets off the USD. But as your broker has bought the USD stock to write a CFD around, they have still had to lodge USD with the exchange for the purchase, and will, therefore, pass the costs of this on to you.
Some institutional or professional brokers are reluctant to do automatic FX conversions for clients trading in different currencies, as some like the currency exposure. Plus a currency can move 10%, so your broker would be susceptible to client complaints if the 10% move was in their favour.
If you are trading on markets around the world, make sure that you regularly check your currency exposure and instigate conversions where necessary.
6. CFD Position Margin Uplifts
As above with stock suspension, risk departments have the right and the responsibility to change initial margin rates when stocks become less liquid or more volatile. Or when currencies may become susceptible to massive price moves because of political events.
This is for the broker’s protection as well as the client’s to ensure that everyone can meet end of day commitments.
Be prepared that if you are trading in volatile or illiquid stocks that your margin rate can be increased with no or very little notice.
So ensure you are not fully invested and have capital for extra initial and variation margin.
CFD Trading Tips: Where To Find Them & What To Avoid
There are two types of CFD trading tips. Firstly tips on what to buy and sell, then secondly tips on how to improve your trading.
We've covered strategies to improve your CFD trading which covers the basics, but if you are looking for CFD trading ideas on what to buy and sell here is what to look out for and what to avoid.
But first, a quick note on risk: If you don't know what CFD trading is or what CFD trading means you probably shouldn't be doing it.
Are advisory CFD services any good?
In a nutshell, no. The FCA has all but put a complete stop to high-pressure sales tactics used by rogue advisory CFD brokers to fleece their clients.
The days of getting pitched stocks by an ex-Carphone Warehouse salesman are over. They moved to binary options, but have now moved offshore to flog crypto trading scams.
However, what this has meant is that the traditional and reputable CFD brokers are no longer allowed to give advice or even implied advice on what to buy or sell when CFD trading to retail or private clients.
If you're a private client all you'll get from brokers is some fairly bland market commentary or some non-commital technical analysis.
CFD brokers are allowed to advise professional or institutional clients and give them CFD tips, but it's unlikely that any properly regulated CFD stockbroker in the UK can give tips to correctly classified private traders.
So, if an advisory CFD broker is pushing trading ideas, make sure you double-check who you are dealing with. As they shouldn't really be doing it.
Trading educational courses for tips and CFD trading ideas
Avoid like the plague quite frankly.
There are some good trader educational programs out there but the majority of forex or CFD educators are just trying to flog you a premium lifestyle at a premium price or refer you to an offshore broker where they will share in the profits made from you losing your money.
Where to find buy and sell CFD trading tips and ideas?
If you want CFD trading tips, most financial media produce daily buy and sell recommendations which are often a good source of stimulus.
One thing to remember though is that stock tips that in the papers are usually based on fundamental analysis with a longer-term view as opposed to CFD trading which usually employs market timing and technical analysis as this is more relevant for short term price moves in liquid stocks.
Here are our top providers for CFD trading ideas and tips
- Investors Intelligence - since 1942 they have provided daily long/short trading ideas and model portfolios
- Stockopedia - set up screens and get trading ideas from fund manager strategies
- Trading Central - trading signals based on technical analysis
- Autochartist- trading signals based on technical analysis
- Stockomendation - aggregates stock recommendations
- Real Vision - daily videos from fund managers and trading ideas from analysts
- FuturesTechs - subscription service for professional and semi-professional traders
These services act independently from CFD brokers and are in some cases regulated by the FCA .
They often highlight trading signals and CFD trading buy and sell signals, but it is up to the trader to decide if they are any good and worth of a trade.
You can also get a form of CFD trading tips from the social trading brokers, where you can follow traders and copy their trades. But, picking a trader to follow is just as hard as picking a winning stock. If you look at the people that make money on social trading platforms a lot of them mirror the portfolios of top global growth funds or have just had a bit of luck.
Where to trade CFDs?
Most established CFD brokers have one or more of these services integrated into their CFD trading platform or provide it through a subsidised or separate subscription if asked. If you are looking for a CFD broker you can view our CFD account comparison tables, read our guide on how to compare CFD brokers or find out what to avoid when choosing a CFD platform.
Don't get ripped off by advisory CFD brokers
CFDs are a very high-risk product and should only be traded by individuals who have significant trading experience.
If you are new to trading and investing then they are not for you.
Advisory CFD brokers are not as rampant as they used to be, but they are still around in one capacity or another. So here are our three golden rules to avoid being ripped off by advisory CFD brokers.
One of the most common ways traders get taken in by advisory CFD brokers is by greed. They are contacted and offered trading ideas from a slick sounding city broker from an advisory CFD firm.
There are of course brokers out there that provide an excellent service and really do have their clients best interests at heart. But the majority of advisory CFD brokers may as well be working in a call centre selling conservatories. Generally, they are commission based and their pay is related to how many trades you as their client enter into.
So, they will be on the phone to you all day suggesting buys and sells, in small amounts with high minimum charges taking small profits. On paper, they may well have made you a profit but when you factor in commission and financing charges you'll probably lose.
There is a great phrase that goes around the City:
Why would anyone who drives a Rolls Royce take financial advice from someone that takes the tube to work.
What this means is that it's your money and you know best what to do with it. Don't get drawn into the promise of quick profits.
If you are going to trade CFDs you need to accept that there are risks involved and stick to a set of CFD trading strategies that mitigate risk.
If you want to see the top CFD brokers int he UK that provide an execution only service they see our CFD broker comparison tables.
One thing to bear in mind is that advisory CFD brokers also offer execution only services and will then try to upgrade you to a advisory account on higher commission rates. They are best avoided altogether. Most advisory CFD brokers use the services of the execution only ones then mark the commission up for their supposed added value.