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.
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.
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.
Suspension of Shares
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.
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.
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.
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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.
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.
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Richard founded the Good Money Guide (previously Good Broker Guide) in 2015 and has been a broker for 20 years most recently at Investors Intelligence and previously a multi-asset derivatives broker at MF Global (Man Financial). Richard started his career working as a private client stockbroker at Walker Crips and Phillip Securities (now King and Shaxson) after interning on the NYMEX oil trading floor in New York and London IPE in 2001 & 2000.