An introduction to Contracts for Difference
Contracts for Difference, or CFDs as they are commonly called, are very popular financial instruments with individual traders. But what exactly are they, how do you use them, and what are the advantages and disadvantages involved in trading CFDs? This article seeks to answer all these questions. By the time you’ve finished reading it, you should know whether CFDs are an instrument you would like to trade, and, if so, how to proceed.
What are CFDs?
CFDs allow traders to bet on short-term price movements in a wide variety of financial assets, from currencies to shares to cryptocurrencies, without actually owning or taking physical delivery of the assets. CFDs are contracts between a buyer (such as an individual trader) and a seller (like a broker, investment bank or spread-betting firm), under which the two parties agree to exchange the difference in the value of an underlying financial instrument between the time the contract opens and the time it closes – often over less than one day.
CFDs benefit from several features that make them uniquely valuable to individual traders. For example, imagine that a trader believes the price of shares in ACME is going to rise over the day’s trading. He or she enters into a contract with a CFD broker, agreeing to buy 100 shares in ACME at US$10 a share. But the broker lets the trader put up just 5% of the US$1000 overall value of the contract, or US$50. The shares rise in value by 10%, to US$11, so the overall value of the contract rises to US$1100, giving the trader an overall profit of US$100 over the day, double his US$50 outlay.
The ACME example highlights one of the key advantages and disadvantages of CFDs, as we explain below.
What are the advantages of trading CFDs?
Leverage: You don’t have to put up the full value of the contract but still benefit in full from any gains. In the example above, the broker provider leverage of 20 to 1 (20:1): the trader only had to put up 5% of the value of the contract and leveraged his money 20 times over. Leverage is generally offered in the range of 3% to 50% of the value of the asset. The amount you are required to put up (5% in this case) is known as the margin or the position margin.
Profit from falling and rising markets: You can use CFDs to bet that the price of an asset will rise (going “long” in the jargon) or that it will fall (going “short”). The latter option involves selling CFDs you don’t actually own and then buying them after the price falls so that you can complete the contract you made to sell them at the higher price. For example, suppose you believe ACME’s share price will fall to US$9 each. You agree to sell 100 shares in ACME at the current price of US$10 a share, again using the 20:1 leverage offered by the broker. By the end of the trading day, the price has indeed fallen to US$9 a share. That is when you step in and buy them, so that you have CFDs to sell for US$10 each to fulfil your earlier agreement. Once again, you have made US$100, or double your initial outlay.
Convenience: You can trade CFDs in a multitude of different assets without ever having to take physical delivery, saving on storage, security and transportation costs. For example, you can trade CFDs in gold, and simply profit from price changes in the commodity without worrying about how you are going to store it securely.
Moreover, there are no limits on using CFDs to “short” financial instruments. By contrast, some markets in particular instruments have rules that prohibit shorting or require the trader to borrow the instrument before selling short, or have different margin requirements for short and long trades, making it difficult to balance positions.
Flexibility: You can close a position at any time during the trading day. That means you can hold a position for as long as you want, be it seconds, minutes or hours. You can even hold a position overnight, although there will be a charge for doing so (see below for an explanation of the costs involved in trading CFDs). Moreover, many brokers offer a variety of options when it comes to trade size, allowing a wide range of traders to access the market. This includes beginners and casual traders seeking to experiment with investment strategies while limiting their risk by focusing on small trades.
Ability to hedge: Most people are familiar with the term “hedging your bets” and understand that it involves offsetting risks. Well, it means exactly the same thing in the financial world and is derived from the age-old idea of using a hedge – or fence – as a means of protection. In this instance, you can use CFDs as a way of offsetting your trading positions with balancing trades in case your beliefs about whether those initial positions are likely to rise or fall prove wrong. CFDs are ideal hedging tools because you can use them to bet that an instrument will rise or fall at a relatively low cost. So, you can take a long position in shares in XYZ that will profit should the price rise, while taking out a short position that will prove profitable should the XYZ share price fall. In other words, instead of selling XYZ at a loss should your expectation of the share price moving higher prove wrong (and draining your limited financial resources in the process), you can open an additional short position that will generate earnings to help offset any losses from your initial position.
You can also use CFDs to insure against a rise or fall in any investment you have other than CFDs. Suppose, for example, you have a standard portfolio of shares in global equities that you wish to keep invested for the long term. Now imagine you anticipate that global equities will soon encounter turbulence and fall sharply before correcting. You could sell all the shares in your portfolio in the belief that you’ll be able to buy them back at a much lower price. But that could prove costly in terms of transaction expenses and taxes, and it is risky: global equities might rise sharply and you might not then be able to buy them back at a lower cost. Alternatively, an investor fearing a market correction could short-sell an equivalent amount of CFDs in the same shares, enabling them to take advantage of the short-term downtrend. At the same time, the investor continues to hold the shares within the investment portfolio, in the belief they will thrive in the long term.
Exposure to a huge range of financial assets: You can use CFDs to gain exposure to thousands of underlying financial instruments around the world from just one platform.
Tax advantages: Unlike traditional share dealing, there is no stamp duty to pay on a CFD trade as you never take physical ownership of the underlying asset.
What are the disadvantages and risks of trading CFDs?
There are significant benefits to using CFDs to access the potential profits to be derived from trading financial markets, but there are also considerable risks that any would-be trader should be aware of before taking the plunge into trading these complex financial products.
Leverage: As we have seen, this is one of the main advantages of CFDs to traders, but ironically it also poses the main threat. Leverage exposes a trader to greater potential profits but also greater potential losses. Let’s use another example to explain why. Suppose you buy 10,000 CFDs in XYZ shares at 280 US cents. The broker provides you with leverage of 5:1 (or 20%), so instead of putting up US$28,000 to own the shares, buying CFDs allows you to gain exposure to the shares with just US$5,600 of your cash. The shares subsequently rise in price by 10%, to 308 cents, and the overall value of the position in those 10,000 shares is now US$30,800. An initial deposit of just US$5,600 has generated a profit of US$2,800, providing a 50% return on your investment, compared with just a 10% return if the shares were bought physically.
But what happens if the trade moves against you and the price of XYZ shares falls by 10%? At 252 cents per share, the overall value of the position is now US$25,200. An initial deposit of US$5,600 in CFDs has produced a loss of US$2,800, or 50% of your investment, compared with just a 10% loss if the shares were bought physically.
Moreover, if the capital in your account falls below a certain level, you may be subject to a “margin call”, where the broker asks you to put up additional funds to balance the account. If you fail to do so, it may close your positions, so crystallising your losses.
You can protect against potential losses to a certain degree. Brokers such as CMC Markets, for example, incorporate negative-balance protection into retail accounts, so your losses will be limited to the value of the funds in your account.
Constant monitoring: You need to be alert to possible changes in your position at all times. Market volatility and rapid changes in price – which could arise outside normal business hours if you are trading international markets – can cause the balance of your account to change quickly. If you do not have sufficient funds in your account to cover these situations, your positions will be automatically closed.
Market volatility and gapping: Financial markets can be very volatile and the prices of financial instruments can rise or fall precipitately at times, jumping to a much lower or higher price rather than moving gradually. This is called gapping and it can have a significant impact on traders. For example, traders may use stop-loss orders to limit losses. This involves specifying a price at which your position closes out if an instrument’s price goes against you. When gapping occurs, however, those stop-loss orders may be executed at unfavourable prices – either higher or lower than you may have anticipated, depending on the direction of your trade.
It is easy to take on too much risk: Because the cost of trading is low, due to leverage, it is easy for investors to be lulled into a false sense of security and take on more trades than is prudent. This can leave them overexposed to the markets at any given time, such that their remaining capital would be insufficient to cover losses across the portfolio. If multiple positions go wrong, it can spell financial ruin for those who adopt a less than cautious approach to CFD trading.
Lack of ownership: This is another characteristic of CFDs that brings benefits but also disadvantages. Because you don’t own the underlying asset, you can’t gain from the benefits of ownership, such as the income provided at set periods by shares or bonds. Even if you factor in forthcoming dividend declarations when buying CFDs in shares, for example, you will only benefit at a fractional rate compared with the payout involved in actual share ownership.
Limited advantages over time: Because of the above point and others, you should only view CFDs as a short-term trading strategy, rather than a long-term investment option. Overnight financing charges alone can render the cost of long-term ownership of long positions prohibitive.
Counterparty risk: This relates to the risk that the counterparty to the trade, the broker in the case of CFDs, could default on the deal. Such risk is minimised by choosing a reputable broker in a well-regulated legal environment, but it still cannot be overlooked.
Volatility can widen spreads… and costs: Severe volatility in markets or in a particular product can cause brokers to widen spreads, which will affect the prices paid by the trader when entering and exiting positions, potentially negatively impacting trades and increasing losses.
How do CFDs work?
CFD trading is relatively simple. Brokers provide the software that connects traders to the market. There are many to choose from and many factors to consider (see Choosing a broker). After selecting a broker, you log into their platform and select the financial instrument you wish to trade, having previously determined whether you believe the price will rise or fall.
You will always see two prices quoted for CFDs: the buy price (also known as the offer price), at which you can buy the contract from the broker or open a “long” position; and the sell price (or bid price), at which you can sell the contract to the broker or open a “short” position. Buy prices are always slightly higher than the current price quoted on the market, and sell prices are always slightly lower. The difference between the two prices is the “spread”, and this gives the broker a profit to make it worth their while dealing in CFDs. For example, ACME could be trading at a sell/buy price of 1,599/1,600 US cents, the sell price (i.e. the money you would receive for this CFD if you sold it to the broker) being slightly lower than the buy price (i.e. the money you would pay the broker to buy this CFD at the same moment).
Examples of profitable positions
It is important to know the costs involved in trading CFDs to determine whether a trade will be profitable.
Example A – long position
XYZ Enterprises is trading at a sell/buy price of 1,599/1,600 US cents. You think the price is going to rise and decide to buy 1,000 share CFDs because you want to profit from the gains. You only have to put forward 5% of the total position’s value from your own funds as the position margin. In this example, your position margin will be US$800, or 5% x 1,000 units x 1,600 cents buy price. Remember, though, that if the price moves against you, you may lose more than your initial position margin.
You are proved right and the sell/buy price rises to 1,625/1,626 cents over the next hour’s trading. You decide to close your position by selling at 1,625 cents (the new sell price). The price has moved 25 cents (1,625 minus 1,600) in your favour. Multiply this by the size of your position (1,000 units) to calculate your profit, which is US$250.
You also incur the following costs, based on a commission charge of 0.10%:
- 1,000 (units) at 1,600 US cents (price) x 0.10% = US$16.00
- 1,000 (units) at 1,625 US cents (price) x 0.10% = US$16.25
- Total commission = US$32.25
Therefore, your total profit for your successful trade on XYZ Enterprises is your gross profit minus total commissions:
- US$250.00 minus US$32.25 = US$217.75 net profit
Example B – short position
XYZ Enterprises is again trading at a sell/buy price of 1,599/1,600 US cents. This time you think the price is going to fall, so you decide to sell 1,000 share CFDs in order to profit from that fall in price. You only have to put forward 5% of the total position’s value from your own funds as the position margin. In this example, your position margin will be US$799.50, or 5% x 1,000 units x 1,599 cents sell price. Remember again, though, that if the price rises, you may lose more than this initial position margin.
The price does indeed fall in the next hour’s trading, to 1,549/1,550 cents. You decide to close your trade by buying back at 1,550 cents (the new buy price). The price has moved 49 cents (1,599 minus 1,550) in your favour. Multiply this by the size of your position (1,000 units) to calculate your profit, which is US$490.
You also incur the following costs, based on a commission charge of 0.10%:
- 1,000 (units) at 1,599 US cents (price) x 0.10% = US$15.99
- 1,000 (units) at 1,550 US cents (price) x 0.10% = US$15.50
- Total commission = US$31.49
Therefore, your total profit for your successful trade on XYZ Enterprises is your gross profit minus total commissions:
- US$490.00 minus US$31.49 = US$458.51 net profit
But what happens when your predictions for the price of a financial instrument prove to be wrong? The easiest way to see is by considering the two examples below.
Examples of losing positions
Example A – long position
Imagine you were wrong when you bought XYZ Enterprises at a sell/buy price of 1,599/1,600 US cents in the expectation that the price would go up. Some unexpected news causes the sell/buy price to fall to 1,549/1,550 cents over the next hour, and you believe the decline will continue. You try to limit your losses by closing your position at the new sell price of 1,549 cents.
The price has moved 51 cents (1,600 minus 1,549) against you, and you need to multiply this by the overall size of your position (1,000 units) to calculate your loss of US$510.
The total commission charges you incur are as follows:
- 1,000 (units) at 1,600 US cents (price) x 0.10% = US$16.00
- 1,000 (units) at 1,549 US cents (price) x 0.10% = US$15.49
- Total commission = US$31.49
So, your net loss on XYZ Enterprises is calculated by adding the cost of commissions to your gross loss:
- US$510.00 plus US$31.49 = US$541.49 net loss
Example B – short position
Now suppose you were also proved wrong when you sold XYZ Enterprises at a sell/buy price of 1,599/1,600 US cents in the expectation that the price would fall. Demand for the shares surges on an unexpected takeover bid, and the sell/buy price rises to 1,649/1,650 over the next hour. The signs are that the gains will continue, so you try to limit your losses by closing your position at the new buy price of 1,650 cents.
The price has moved 51 cents (1,650 minus 1,599) against you, and you need to multiply this by the overall size of your position (1,000 units) to calculate your loss of US$510.
The total commission charges you incur are as follows:
- 1,000 (units) at 1,650 US cents (price) x 0.10% = US$16.50
- 1,000 (units) at 1,599 US cents (price) x 0.10% = US$15.99
- Total commission = US$32.49
So, your net loss on XYZ Enterprises is calculated by adding the cost of commissions to your gross loss:
- US$510.00 plus US$32.49 = US$542.49.
What financial instruments can I trade with CFDs?
Below are the major financial assets you can gain exposure to via CFDs.
Currencies: These provide traders with a huge variety of options because currencies are traded in pairs against each other, such as the US dollar against the euro. There are hundreds of currency pairs available to trade via CFDs. The global market is huge with around $6.6 trillion traded every day in foreign exchange markets. So, the market in major currencies is highly liquid, meaning it is easy to get in and out of positions.
Shares: You can buy CFDs in most major global stocks. Like the forex market, the global share market is huge, with the total value of global equity trading worldwide amounting to 37.7 trillion U.S. dollars in the second quarter of 2021. Again, that means you can choose from a huge number of highly liquid shares. Price movement in shares can also be large and this volatility offers significant potential gains, as well as losses, for traders.
Indices: These provide a representation of an overall market. For example, a collection of different stocks are grouped together and an average price is taken for all of these stocks, creating the price of the index. Well-known examples include the Dow Jones and the S&P 500 in the US. CFDs provide a quick and convenient way to trade the overall stock market, or any other market, rather than via individual shares or components of the index. Indices tend to be less volatile than shares in individual companies and hence are less risky. They are also powerful forward-looking indicators for both global and country-specific economies so if you have a particular expertise in economic, indices could be for you. More the appeal of trading index CFDs, includes low trading costs and lower margin requirements, compared to stock CFDs – reaching as low as 1% in some markets.
Cryptocurrencies: You can trade a variety of popular cryptocurrencies with leverage, from Bitcoin and Ethereum to TRON and NEO. The global cryptocurrency is growing rapidly and is forecast to rise from US$1.49 billion in 2020 to reach US$ 4.94 billion by 2030. Prices are, however, highly volatile, magnifying the potential for large profits and losses. One of the key advantages of cryptocurrency CFDs is that you don’t own the underlying assets, thus preventing the risk of loss due to a cybersecurity breach.
Commodities: You can gain exposure to the hugely diverse range of commodities, from oil to gold to copper, using CFDs. Commodities are subject to a huge range of influences from global demand and supply to political shocks, that disrupt supply and demand, and are highly influenced by the economic cycle. Consequently, commodities are susceptible to sudden price movements that may present trading opportunities.
Again, this is a highly liquid and massive market. The underlying value of just the market in crude oil (the world’s most traded product) in 2019 – prior to the pandemic – was US$986bn
Bonds: Effectively IOUs issued by governments, companies and other entities, the bond market, also known as the fixed income market, because of the regular set payments these instruments provide, is another of the world’s biggest financial markets. Similar to stocks, bond CFDs provide exposure to a huge range of issuers. The fixed income market tends to be far less volatile than the stock market and key influences include the outlook for inflation and interest rates and the underlying creditworthiness of the issuer. One of the advantages of bond CFDs is that margin requirements can be as low as 20%, making them attractive to investors keen on using leverage to invest.
Interest rates: You can use CFDs to bet on the future direction of interest rates in a wide range of major global markets. The advantages of interest CFDs include relatively attractive margins of 20% and low spreads compared to other products.
Are CFD brokers regulated?
Unregulated, unlicensed brokers are very common while many will register in jurisdictions that impose low-regulatory environments. We recommend that traders should always use CFD brokers that are regulated by at least one national authority. These regulators set rules designed to protect citizens from financial scams and unethical businesses. Some CFD brokers are regulated by more than one national authority. In Australia, the national regulator is the Australian Securities and Investments Commission (ASIC). To protect traders, ASIC-regulated CFD brokers are required to comply with the following rules:
- Segregated Accounts: CFD brokers are required to keep traders’ money in a separate bank account from their own. This means that traders can get their money back if a CFD broker goes bankrupt.
- Negative Balance Protection: Traders with ASIC-regulated CFD brokers can never lose more money than they have in their trading account. This means that any negative balance cannot be claimed by the brokers.
- Leverage Limits: CFD brokers regulated by ASIC can only offer leverage of 30:1. This means that traders can only borrow from the broker 30 times more than they have in their trading account.
- Regular Audits and Inspections: ASIC-regulated CFD brokers are subject to audits of their finances and surprise inspections of their trading setup. This prevents brokers from cheating their traders.
There are many other regulators around the world. Apart from ASIC, the best regulators are CySEC (Cyprus Securities and Exchange Commission) and the FCA (Financial Conduct Authority ). The European Securities and Markets Authority (ESMA), another excellent regulator, is responsible for regulation in the European Union. Like ASIC, ESMA’s rules include negative balance protection on a per-account basis; a restriction on the incentives offered to trade CFDs; and a standardised risk warning, including the percentage of losses on a CFD provider’s retail investor account.
Regulated or unregulated broker?
Brokers in territories in highly regarded regulators are required to adhere to strict guidelines, which are designed to protect consumers. These can include keeping their client funds in segregated (or separate) accounts from their company accounts, and not using their traders’ money for any other purpose. They may also be required to have a minimum in operating capital, which increases according to the number of traders and the trading capital. Licensed brokers must have a compensation scheme in place to compensate clients if the company breaks the law.
However, you don’t have to use a regulated broker. You can open an account with an offshore broker, i.e. a company based outside your country of residence.
There are advantages and disadvantages to using an offshore broker. The main advantage is that you won’t be subject to the same restrictions as to when using a regulated broker. They may offer higher leverage. In Australia, for example, retail traders are limited to 30:1 leverage, whereas an unregulated broker could offer a 500:1 ratio. Offshore brokers also tend to have lower costs, which they can pass on to you in terms of lower commissions or better spreads.
The disadvantages include the fact that if you use a broker registered in another country, it will be subject to the regulations of that country and it may not be as well supervised. If things go wrong and your broker is registered in a country thousands of miles from your home country, it might be difficult to gain legal redress.
Checking whether a broker is regulated
You can check if a broker is regulated or not, by verifying this information through the official brokers’ website first, as regulated companies always provide details of their license. You should verify a license through the official regulatory website.
CFD trading is not allowed in the USA.
Choosing a broker
There are many factors to consider when choosing a CFD broker. These include:
Trading fees
There are a number of fees and costs associated with trading CFDs. As explained earlier, when you open a CFD trade you must pay a portion of its full value up front. This deposit is called the margin, and the percentage you have to pay on the overall value of the trade will affect the affordability of your trading.
The costs of CFD trading include the commission charged by the broker and the spread, i.e. the difference between the bid and offer prices at the time you trade.
Commission (normally around 0.10%) is charged when you buy and sell a CFD on shares. The commission charge varies depending on the country where the share product originates.
However, commissions are not charged on other products, such as foreign currency, indices, cryptocurrencies, commodities and treasury instruments. As an example, the broker CMC Markets, a UK-based financial services company, charges commissions that start at 0.10% or US$0.02 per share for US-listed shares, subject to a minimum charge of US$10.
So if you bought a 600 unit trade in Caterpillar at a price of 80.95, the commission would amount to $12.00 based on the following calculation:
600 (units) x $0.02 (commission charge per unit) = $12.00
But a 300-unit trade in Caterpillar at a price of 80.95 would incur a minimum commission charge of $10.00 based on the following calculation:
300 (units) x $0.02 (commission charge per unit) = $6.00
The actual commission on this trade is less than the $10.00 minimum commission charge on US share CFDs, so instead the minimum commission charge of $10.00 is applied.
Spreads: The spread is the way the broker earns money on dealing in non- share CFDs. It is simply the difference between the price you can buy a CFD at, and what you can sell it at. The price at which you buy (bid price) is always higher than the price at which you sell (ask price), and the underlying market price will generally be in the middle of these two prices. Trading spreads add costs to a trade and will fluctuate along with an assets price and trading volume.
These are the internationally regulated Forex brokers with the lowest trading costs (spreads + commission) for clients:
Financing charge
If you hold a long position, you will also be charged interest to hold that position overnight. This is referred to as a financing charge and is calculated as the current overnight interest rate charged by the major banks plus 2% to 3%. If you hold a short position overnight, you will receive a payment of the current overnight interest rate minus 2% to 3%. For example, the broker IG says that for long positions it charges 2.5% above the relevant interbank rate so if the relevant interbank 1-month rate is 0.5%, you would be charged 3.00%. For short positions, traders receive the relevant interbank rate, minus 2.5%. So if the interbank rate is greater than 2.5%, it will credit your account; if the interbank rate is less than 2.5%, your account will be debited.
As an example, if the relevant interbank 1-month rate is 0.5%, you would be charged 2.00% (annualised).
Weekend fees: You will be charged extra if you keep a position open over the weekend as opposed to overnight.
Withdrawal fee: Some brokers may charge a fee to withdraw money. eToro, for example, says it charges US$5 for withdrawals, “to cover some of the expenses involved in international money transfers”. The fee may vary on the type of currency involved. Some brokers may offer a set number of free withdrawals per month.
Conversion fees: Some brokers will charge a fee to convert the cost of converting a withdrawal in one currency into another. eToro gives an example of the costs as being around US$10 on converting a deposit of £2000 into US dollars.
Inactivity fee: These are charged on the balance in an account if it goes unused for a set period. One broker, for example, charges a $10 monthly inactivity fee on any remaining available balance if there has been no log inactivity for more than 12 months.
Regulation: Before choosing a broker, you should determine the regulatory environment in which they operate. There are multiple regulators around the world, each regulating to a different standard. The most trusted regulators actively create new regulations and enforce existing rules. They continually post warnings and prosecute companies that don’t comply with the rules. Enforcement sets these organisations apart from their counterparts. The best regulators are the FCA in the UK, ASIC in Australia, and MAS in Singapore. We recommend choosing brokers regulated by a number of the best regulators. Such brokers include CMC Markets, Forex.com, Pepperstone, MarketsX and IG Markets.
Trading conditions: Traders want to know the cost of trading at each broker. As our focus is on beginners starting their trading career, we look at the minimum deposit required for an entry-level account, and the cost of trading. We especially like Tickmill, Exness and AvaTrade for their trading conditions.
Minimum deposit: A trader should only deposit an amount they would be ready to lose. CFD trading is a high-risk activity, so brokers that require traders to deposit amounts they potentially cannot afford to lose are less favourable to the client. While it is almost impossible to start a trading career with as little as US$5, we do value brokers that have entry-level accounts that require less than US$100.
Trading platforms: Traders want CFD brokers to offer them a choice of software platforms. While every Forex broker will provide clients with at least one trading platform option, we appreciate brokers that offer multiple options, including MetaTrader4, MetaTrader5, cTrader, and fully mobile and web-browser-compatible experiences.
We especially like Pepperstone, OctaFX, IC Markets and FxPro for their commitment to offering their clients all the major trading platforms.
Assets available: Traders need to know what kind of CFD products can be traded with each broker. CFD products could include:
A wide variety of CFD products allows traders more opportunities for trades. These are the internationally regulated Forex brokers with the highest number of CFDs:
Deposits and withdrawals: Traders want to deposit and withdraw account funds quickly, by a variety of methods and without fees. Most brokers will allow traders multiple instant funding methods for deposits without administration fees, but some brokers make it harder or more expensive to withdraw account funds. The best brokers will process withdrawal requests within 24 hours, by multiple methods and without charging processing fees. We especially like FxPro, Go Markets and CMC Markets for their commitment to quickly returning clients’ funds.
Can CFD brokers help me get started?
CFD brokers are keen to attract new traders but many are deterred by their fear that they could lose money because they don’t understand the market or how to trade it. Consequently, many reputable CFD traders offer educational material, demo accounts – where beginners can learn how to trade with the fear of losing real money – as well no deposit bonuses, which again offer give you a free, first deposit that allows you to start trading without risking your own capital. You also need to be aware of factors such as customer service hours, the quality of customer service and response times. All of these factors, which will help determine whether you can trade forex successfully or not, are discussed below.
Education and analysis is vital for beginners
Beginner traders need a high-quality, structured beginners’ course to get started with CFD trading. Unfortunately, our research has found that all too often, education sections have been removed by brokers, or replaced with a set of cheaply produced blog posts. Beginner traders need a structured, well-presented course, written by the broker to get an effective start at trading. An unlimited demo account offers the beginner an indefinite period to learn hands-on, in a risk-free trading environment.
Traders of all levels also want to be able to access reliable trading ideas. Research and market analysis are always better when produced in-house by the broker, and benefit traders the most when they are produced frequently. Third-party blog posts do not show the same dedication and expertise, and thus a strong emphasis is placed on frequent and in-house updates.
These are the ASIC-regulated CFD brokers with the best educational material for beginners:
Demo accounts
The best place to learn is with a demo account where the trader does not risk their account funds. We favour brokers that offer unlimited demo accounts.
These are the ASIC-regulated CFD brokers with the best demo accounts in 2023:
Customer support: Traders want their broker to be available around the clock, via many different channels and in their own language. We favour brokers that offer phone, email and live chat support 24/7. As most of the best CFD brokers are international, we believe that the more languages the support team speaks, the better. Broad language support gives our global audience a way to get their problems solved in the easiest possible way.
We especially like FXTM, Plus500, FP Markets and easyMarkets for their commitment to supporting customers.
How we score brokers
We score brokers on seven different areas, collecting multiple data points on each. The highest score a broker can receive in each area is 5. Each of the areas has a weighting, which we use to calculate a final score for each broker. The areas and the weightings are as follows:
- Trust and reputation – 20%
- Trading conditions – 20%
- Platform and tools – 17.5%
- Assets available – 12.5%
- Deposit and withdrawal – 10%
- Education and research – 10%
- Customer support – 10%
What makes a bad CFD broker?
Poor regulation: Make sure you choose a broker that is regulated by multiple highly-rated regulatory agencies.
Poor support: Choose a broker that provides 24-hour support and that responds quickly to requests for help.
Unclear costs: Ensure you understand the charging structure. Check that the broker provides competitive spreads and/or commissions.
A narrow range of instruments: Once established as a trader, you might want to expand into other financial instruments than those you initially focused on.
Counterparty risk: When you buy or sell a CFD, you are entering into a contract with your broker. Make sure you are dealing with a reputable company. If they go bust or simply refuse to honour the contract, there is little you can do if you have dealt with an unregulated or poorly regulated broker.
Unsubstantiated claims: Beware of brokers that downplay the risk of trading CFDs or make wild claims about the profits that can be made.
Poor educational materials: If you are a beginner, it is extremely helpful to use a broker that can help you learn how to trade.
No demo accounts: Before you start trading with your own money, you should spend as much time as possible trading virtually on demo accounts with no money involved.
CFD Brokers to avoid
Our CFD brokers to avoid directory includes brokers that we have not reviewed, but which remain an option for traders. These brokers are not recommended for traders, and the directory is intended as a research tool for anyone seeking a professional opinion; if your current broker has not been evaluated by us, we hope that our selection of reviewed brokers will offer you a better-regulated and superior alternative.
FAQs
Can I make money trading CFDs?
Yes, you can but as one broker puts it “you first need to hone your trading skills and have a lot of discipline, practice, and patience to do well in the market. Successful CFD trading is possible, you just have to do it right”. (FP Markets) Remember this is not a get rich quick scheme and there are considerable risks involved. Most successful traders aim for a consistent and modest but reliable return on their investment. A strategy that works consistently and is constantly being updated and improved is usually the best way to gain financial independence through CFDs.
How do you successfully trade CFDs?
The short answer is hard work. Spend as much time as possible researching the market and how it works. Then choose a broker and learn how to trade on their platform using a demo account. Try a variety of simple strategies and the financial instruments you wish to trade. Focus on a few strategies and a small number of positions when you start trading. Learn to keep your emotions in check and never trade larger amounts than you can afford to lose.
How much money do I need to trade CFDs?
You can open a CFD no deposit bonus account without any money or deposit account with as little as US$100. Clearly, the more money you put up the bigger your potential profits – and losses – are likely to be. It is a good idea to start small and increase the amounts you are trading slowly as your knowledge and experience also builds.
Is CFD trading legal?
Yes, it is legal in most jurisdictions. The USA is an exception.
Is CFD trading taxable?
Yes, the profits on CFD trading are taxable, although rules will vary from one jurisdiction to another. Since you don’t own the underlying asset when trading CFDs, there is no stamp duty to pay in the UK, for example. However, you will be subject to capital gains tax on any profits.
What are the risks?
CFDs are complex instruments and entail a high risk of losing money. Between 61%-79.8% of retail investor accounts lose money when trading CFDs, according to some estimates. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money very carefully.
The main risks are:
- Leverage maximises gains but it also magnifies losses, which means you could lose more than your initial outlay.
- Counterparty risk. You are entering into a contract with the broker and there is also always the risk that the other party to the contract could go bust or, in the case of an unregulated broker, simply renege on the deal.
- Contractural risk. The contract between you and the broker outlines your speculations about the value of the financial product or underlying asset and is a legally binding agreement. Unless you have some trading knowledge and the time and patience to digest the provisions of the contract, you could be adversely affected by a clause in that contract.
- Volatile markets. Even though you may be speculating on the price movements of an individual financial asset, such as shares in a bank, the price of the underlying asset can be affected by movements in the wider market that have nothing to do with that underlying asset. So negative and unexpected economic news could cause the price of all shares in the market to fall sharply. Furthermore, because CFDs are highly leveraged, even a tiny dip in the market can result in large losses.
- CFDs can move quickly. Known as ‘gapping’ a CFD can move in price between, for example, US5.50 and US$6.00 without stopping at any of the price points in between. Therefore, even if you’d planned to close a trade at £5.55, you might not get that choice. Gapping can even negate stop-loss mechanisms. Because the prices move so quickly, this opens up traders to increased risk.
How to decide if CFDs are right for you?
By now you should have a good understanding of how CFDs work, their pros and cons and know how to proceed. But remember before you decide whether CFDs are for you, you should go through the following checkpoints before reaching your conclusion because CFDs are only likely to be for you if you:
Possess a high tolerance to risk, and are not at all risk-averse.
Understand that while you can make money, you can also lose a lot.
Acknowledge CFDs are highly complex products and that you should undertake a great deal of research and spend a lot of time trading on demo accounts before considering going live.
Understand that while leverage can magnify your profits, it also has a hugely exaggerated impact on losses.
Recognise the prudence of using reputable brokers in well-regulated environments.
Be prepared to only risk money you can afford to lose.
Forex Risk Disclaimer
Trading Forex and CFDs is not suitable for all investors as it carries a high degree of risk to your capital: 75-90% of retail investors lose money trading these products.
Forex and CFD transactions involve high risk due to the following factors: Over-leveraging, unpredictable market volatility, slippage arising from a lack of liquidity, inadequate trading knowledge or experience, and a lack of regulatory protection for clients.
Traders should not deposit any money that is not disposable. Regardless of how much research you have done, or how confident you are in your trade, there is always a substantial risk of loss. (Learn more from the FCA or from ASIC)
Our Methodology
Our State of the Market Report and Broker Directory are the results of extensive research on over 100 Forex brokers. The explicit goal of these resources is to help traders find the best Forex brokers – and steer them away from the worst ones – with the benefit of accurate and up-to-date information.
With over 150 data points on each broker and over 3000 hours of research and review writing, we believe we have succeeded in our goal.
In a world where trading conditions and customer support can vary based on where you live, our broker reviews focus on the local trader and give you information about these brokers from your perspective.
All research has been conducted by our in-house team of researchers and writers, gathering information from various company representatives, websites and sifting through the fine print. Learn more about how we rank brokers.
Accepts Australian Clients. Average spread EUR/USD 0.10 pips with 6 USD commission round turn on the trading account with lowest minimum deposit. Max leverage 30:1. Islamic account available. MT4, MT5 & IRESS platforms supported. FP Markets is regulated by CySEC and ASIC.
