The opportunities for simple online trading have multiplied in recent years. Trading has never been easier. Stocks, currencies, commodities and even crypto-currencies are accessible for trading from many platforms more or less optimised for this purpose. Online brokers have even come to specialise in order to offer a better trading experience thanks to technical tools developed for this financial speciality.
We hear a lot about CFDs in the investment community. The nature of this financial instrument still escapes some amateurs. What is a CFD? How does it work? What are the criteria for choosing a reliable CFD broker? Its advantages and disadvantages? Read our complete presentation of the microcosm of financial markets.
What is a CFD?
Before talking about the operators who make their trading possible, it is essential to understand what a CFD is. It is an acronym that stands for Contract For Difference. It is often translated as Contract for Difference. This means in the context of stock exchanges that a CFD is a financial product that allows a trader to speculate on the difference in price between the time the order is placed and when it is closed. Up or down. It is on this difference that the CFD trader makes his profits when his strategy pays off.
From a more technical point of view it is a derivative of “classic” financial instruments which offers the possibility to speculate in a simplified and fairly inexpensive way on stock market indices (CAC 40, Dow Jones 30, DAX 30, etc.), raw materials (gold, oil, silver, etc.), shares of large companies listed on the stock exchange (Apple, Renault, etc.), crypto currencies (CFD Bitcoin, Ethereum, Ripple, etc.) and currencies (CFD Forex: Euro, US Dollar, etc.). They are called the underlying assets. A CFD reproduces the variations of the “original” underlying asset in a very precise way (on the principle of a Market Maker). CFD trading involves betting on price movements either up or down
How does the CFD exchange work?
We have set the overall framework with this definition of the CFD as clear and exhaustive as possible. But how does this work in the reality of the financial markets?
As noted above, CFD trading is based on speculation in the price of an underlying asset. If the CFD trader considers, after technical analysis of stock market signals, that the price of the CFD financial instrument is rising, he will “Buy” it. On the contrary, if the CFD trader believes that the price of the CFD financial instrument is trending downwards, he is allowed to “Sell” it short. That is to say that he will sell it before he has it in his possession.
In view of the complex mechanics, it is therefore essential to use an online CFD broker specialised in this type of transaction. The CFD software copies the actual fluctuations to allow traders to make realistic and therefore potentially profitable investments.
Types of CFD scholarships
With the democratisation of virtual tools for trading, CFD Online is experiencing a rise in interest among the trading community, both beginners and experienced. We will develop a little further the reasons why stock market CFDs are so attractive. They can be found in different strata of financial investment in global trading markets:
- stock market indices: CFD CAC 40 for UK, CFD Dow Jones 30 for the United States for example
- equities with a wide range of underlying assets derived from the Stock Market
- crypto-money which is a new and very dynamic pole: Bitcoin, Litecoin, Ripple etc.
- commodities, which are a favourite investment for long term traders
- forex CFDs with highly volatile currency pairs
Why open a CFD trading account?
Playing the stock market via a CFD broker has many advantages. It is indeed a very special way of trading the assets concerned. However, most platforms open to everyone are CFD brokers, more or less specialised.
The leverage effect
All traders are attracted to this type of site since it is possible to multiply their investment capacity through leverage. It is the broker who “lends” the difference to the investor. With a position made up of a larger volume the profits are also higher. Leverage at CFD brokers is variable, but it can be very high. It is not uncommon to find a 200:1 ratio on some CFD financial instruments.
Boosted by this highly speculative operation, the fees associated (brokerage, account management, long position, etc.) with CFD trading are often much lower than those applied to a securities account, for example. This directly improves the profitability of a portfolio of assets significantly.
As with many stock market investments, CFD trading in UK benefits from a fairly attractive tax regime. Indeed, it is possible to deduct capital losses on capital gains realised during a fiscal year.
Opening a CFD account allows you to benefit directly from all financial products via a single interface. The broker reserves the right to open rights on more or less instruments depending on the account level (Standard, Premium, VIP, etc.) but the catalogue, even basic, makes it possible to trade currency pairs, indices and crypto-currencies from a single trader account.
More precise management
A CFD portfolio allows you to split your index points. In other words, to place orders on more controlled volumes with reduced CFD benchmarks. A CFD broker is remunerated on spreads (commissions) which are calculated in pip. This is a reference value that shows the difference (up or down) between the opening and closing of the position. CFD orders offer low benchmark standards, starting at 1 pip depending on the product. Management therefore becomes easier with more efficient controllable modulations.
Access for all
By extension by offering low threshold position openings, low commissions and high leverage, CFD trading becomes truly attractive to retail investors. It is certain that professionals take advantage of this advantageous situation with potential risks proportional to their investment capacity. Just look at the hedge funds that use CFD trading. More than half of them close after 2 years.
Trading CFDs offers real flexibility as quotes are constant, 24 hours a day. If a position has remained open between the closing of a stock exchange and its re-opening, the CFD platform will update the quote in real time with the resulting gains or losses. In addition, CFDs do not have short, medium or long term maturities. It is the trader who retains control of his assets.
Why is it risky to open a CFD account?
The main disadvantage is the leverage effect. We have exposed its natural appeal thanks to the proportional increase in investment capacity (by 2, by 3, by 10, by 30, etc.) which directly impacts the volume of profits upwards.
However, it is essential for the health of one’s capital to keep in mind that leverage is a double-edged sword. It is a basic principle of CFD Finance: what is offered on one side can be taken back on the other. We explained that the CFD broker “lends” the difference to the trader to strengthen his position in the hope of a bigger gain. But if the position is ultimately lost, the losses are proportionally greater as well. To the point of jeopardizing a trader’s account through bankruptcy for example
More and more brokers are including security to avoid negative balances in their platforms. IQ Option or eToro, for example, will systematically close any position that causes an account to go into negative balance
- use only limited leverage appropriate to your trading capacity, or even avoid it while consolidating your portfolio
- many years of experience is highly recommended
- basing your strategy on a high leverage effect is close to a crazy 50/50 bet in the casino
On what criteria is his choice of CFD broker based?
You probably already knew, and you have understood all the more, that online trading is an activity that presents real financial risks. To limit them a little more it is best to choose the CFD broker with whom you intend to make profits
Favour regulated establishments. The regulatory authorities are a guarantee that the stock exchange sites you use comply with a number of legal rules in the practice of online stock exchange transactions. In addition, the funds invested are guaranteed through a partnership with one or more authorised investment banks. The regulatory authorities vary according to the country or geographical area. For example, there is the AMF (Autorité des Marchés Financiers) in UK, CySEC in Cyprus (for the European zone), the FCA for Great Britain.
It is obviously important to sign up to a CFD platform with a wide range of financial instruments. This allows you to diversify your assets from a single account and demonstrates a serious dynamic on the part of the broker
The CFD software part is linked to the notion of platform. Choose an online trading site based on a solid software infrastructure such as MetaTrader (MT4 or MT5 or MetaTrader WebTrader) or ProRealTime. Fewer crashes, fewer bugs and a vital reactivity.
If you are English, it is much better to make sure that the customer service speaks English. This avoids situations of incomprehension that waste precious time. This helps to reduce the mental pressure of the trading profession.
Read customer feedback whenever possible. Especially on the question of the processing time for withdrawal requests. Once again, customer support that takes to heart the validation of withdrawals from user accounts is a positive signal of the broker’s reliability.
Choose a broker that allows CFD trading from a mobile, iOS and Android compatible application. This is your chance to always have your portfolio management at your fingertips. By setting up specific alerts it is possible to increase reactivity and therefore profitability.
Finally, what is the level of CFD training offered by the online broker? This point is really central in the selection of his CFD broker. This can be done through a demo account with the possibility of training with fictitious funds by placing stock market orders in real conditions. The training can be based on tutorials, webinars, articles and analysed stock market news. Most regulated brokers offer them.
A trader’s training can also come to life thanks to a CFD simulation platform. For example Admiral Markets has developed one based on MetaTrader software. It is then possible to simulate stock market trends by precisely setting the type of instruments, leverage, etc., in order to simulate a wide range of market trends. It is an excellent training tool to develop and refine your investment strategies over the short, medium or long term as if you were in a real situation.
Which are the best CFD brokers?
Names of trading platforms are often at the heart of reviews by CFD financial market experts. There are some notable differences between them. However, they all share a common set of specifications which is the backbone of a reliable regulated broker. Your choice is based on other more subjective aspects such as the interface design.
We’ll highlight eToro, which tends to take the top spots in online broker rankings thanks to its high flexibility and social trading dimension that reinvents the notion of investing with CopyTrader and Copy Portfolio.
We’ll also talk about IQ Option, which continues to climb in the esteem of traders with the help of reduced brokerage fees and a truly competitive automatic trading robot (from $100 invested).
Finally, let’s mention BDSwiss with its rational and respectful approach to all trader accounts with low fees, powerful leverage (up to 30:1 on currency pairs) and spreads starting at only 1 pip.
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