Regulated CFD Broker
updated: 24.05.2020 - Compare, Choose, Trade!
General Risk Warning: You should never invest money that you cannot afford to lose! Brokerlytix is not providing any investment advice, we only help you find the best broker suitable for your needs.
What is CFD trading?
CFD trading refers to the trading of contracts for difference. These contracts for difference are derivatives on certain assets such as shares, indices, forex assets, commodities and sometimes even bonds. They depict the fluctuation in price (or rather the balance of the fluctuation) of their assets, whereby leverages of various sizes are possible - from around 1:5 (on some shares) to 1:1000 and even larger.
The opportunities and risks of CFD trading
Leverages of between 1:200 and 1:400 are common in CFD trading. This means that with only a small amount of capital, a trader can gain 20%, 50%, 100% and even more in a matter of minutes or hours. It also means, however, that these derivatives are very speculative, and investors should know the risks well. They can yield large gains from a comparatively small investment, but large losses are also a possibility. Depending on the composition of the CFD and the broker’s conditions, the latter can exceed the trader’s investment many times over if that trader is an institutional investor. For private investors in Europa, as of 2017 the damage is limited to the capital of the position held. The prior obligation to make additional capital contribution ceases to apply following a BaFin prohibition, although it is still possible to make a total loss on a position. Even if a trader possesses the requisite knowledge, CFD trading nevertheless remains a very speculative art. In essence, the investor is opening up a large trading position in the market with very little capital. This entails considerable risks that cannot be completely excluded - not even by a stop-loss order in intraday trading. Price movements which progress so quickly that a stop-loss could not remedy the situation are always a possibility. The difference between the stop-loss rate and the write-off of the CFD (the so-called slippage) can be so large that the result is a total loss. If a CFD is held overnight, the price can fall through a gap to a level far below the stop-loss.
Differences between CFD trading and other trading activities
CFD trading is different from trading with shares, forex lots, bonds or commodity futures because a CFD usually represents a wager on price fluctuations and the trader therefore does not gain any rights to the value of the assets. With a share, for example, as a shareholder the purchaser practically becomes a partner in the company and can thus even be accorded voting rights. A CFD investor, on the other hand, profits or loses solely in accordance with the price development of the underlying asset. They can make gains in both directions - with rising or falling prices. For this purpose there are call CFDs for assets that are likely to increase in value and put CFDs for those that are likely to fall. Trading with CFDs is carried out by specialist brokers in the form of over-the-counter deals. This is referred to as off-exchange trading. The broker sells the CFD as a market maker to the investor and then buys it back again with either a profit or a loss. The broker hedges against the trader’s profits and therefore loses nothing. The broker also gains nothing if the trader loses. The only profit a broker might make here would be a spread and a small order fee on some CFDs (generally share or bond CFDs). The hedging on the part of the broker affects the exposure of their trader. This means that some traders rely on the price of an asset rising, while others depend on falling prices, simply because the traders believe in a range of predictions as to how prices will fluctuate. This balances out to a certain degree, although there will always be a certain preponderance on one side or the other. The broker can balance this out through some trading activity, ultimately resulting in a zero-sum game. The role of the CFD broker as a market maker is another aspect that differentiates CFD trading from other trading activities: the CFDs will only be traded by one particular broker and, in contrast to other derivatives such as warrants or knock-outs, are not positioned on the market. The trader is therefore reliant on the prices determined by the broker and on the dependability of the broker’s technical platform. This means that for CFD trading, the selection made by the broker is hugely important.
The pros and cons of CFD trading
Advantages of CFD trading
- Easily comprehensible products
- Trading with very little capital is possible (with as little as €20)
- Generally no order fees, but fees do apply to shares, bonds or futures CFDs
- CFD can run endlessly and with no time value loss
- Profits can be made on the price of the asset either rising or falling
- The choice of CFDs is enormous due to the very large spectrum of indices, shares, commodities, forex assets, bonds and futures
- The trader deals with high volumes yet low capital
Drawbacks of CFD trading
- Large losses possible due to leverage effect
- Slippage cannot be ruled out, and although stop-loss can serve as protection, it will not always work
- Overnight trading can be very risky due to gaps
- Extensive market expertise is required for successful trading
- How does CFD trading work?
Trading revenue and fees
An important aspect of CFD trading is that for the most interesting assets - currency pairs, indices and commodities - trading is not subject to any fees. The broker only charges a spread, which can turn out to be a very small amount. This is one of the principal differences between trading with CFDs and other derivatives. Knock-outs, for example, function just as well as derivatives as they do as CFDs - they keep track with exchange difference at a ratio of 1:1. Should they be offered by an issuer and positioned on the market, the broker concerned functions solely as an intermediary and therefore does not receive a fee. It is also possible to trade over-the-counter with the issuer (of a bank), for which the broker usually charges a fee that is seldom less than five euros. Discount brokers commonly charge order fees of around €5.90 for a single transaction, even with a very low revenue. Even private traders rely on very small positions. They would want 50 or 100 euros to place a small speculation, for example, as this represents a reasonably affordable sum and the risk can ultimately be minimised under normal circumstances by a stop-loss. The various risks have been explained above, and we have even made mention of the potential for slippage, but such risks do not normally become a reality. In 99% of cases, a stop-loss performs its role very well. As a result the trader is able to make use of a total of 50 euros and only risk the first 10 euros with the first stop. If the price moves in the right direction, if the trader has any doubts they can execute the stop order and bail out with as little as one euro profit - with a two point gain less a one point spread. With a knock-out, the trader must first earn the €11.80 order fee, which is not always successful - especially so with limited capital. This is what makes CFDs so very appealing.
The way CFD trading works: a practical example
The trader watches the Dax and is led to believe owing to a chart trend that a particular price could rise in the next few minutes or hours. The trader therefore buys, say, three call CFDs for 100 euros each with a point spread and places an investment of 300 euros. Order fees are not incurred on index CFDs. The price of these CFDs moves by one euro per Dax point. Consequently if the Dax were to fall by 100 points (which happens almost every day), the CFDs would be worthless. If the Dax rises by 10 points, the trader gains 27 euros, or more specifically 10 euros per CFD minus a one euro spread. The trader hedges the initial risk, if they are skilful enough, with three stop-loss orders:
The one point spread per CFD comes in at this number of points under the purchasing point. The trader is therefore initially risking 6 + 10 + 14 = 30 euros, which corresponds to 10% of the initial investment and, more importantly, is completely acceptable in derivatives trading. The stop-loss gaps were chosen arbitrarily for this example: they could be closer together, but should not be further apart if at all possible, as it is unwise to risk more than 10%. If the price moves in the right direction, the trader executes their three stop orders and can widen the stop gaps if the price development is advantageous, with the result that, for example, the first stop would eventually be 10 points below the price level, the second 30 points below and the third even 50 points under the current price - but only if all the stops have gone above the purchasing point, and each CFD is therefore theoretically in profit. The trader is thus able to overcome even fairly sizeable corrections. At the end of the day the trader pulls their three stops together. The profits would amount to 47% at 50 Dax points (always minus spread), while at 103 Dax points and with all three CFDs in profit, the trader would have earned 100%. In practice traders are usually only able to pull off one or two of the three CFDs by the end of the share price development.
What can be traded in CFD trading?
There are CFDs for practically every type of share that appears on the market, and moreover for all common indices, commodities and currency pairs; brokers offer CFDs for currency pairs on all majors and minors as well as some interesting exotics. CFDs are available for between 50 and 70 currency pairs. Not every broker offers bonds and futures CFDs. The investment universe can easily deal with five or six-digit sums. It is likewise important to know that for a single value such as the Dax or the EUR/USD currency pair, there can be several hundred or even thousands of CFDs, which are often at completely different prices and consequently are associated with various leverage effects. This makes sense as there can be traders who wish to open long-term positions and thus buy a CFD for 400 euros, which is 400 points removed from its total loss and is held without a stop-loss, simply in order to be able to sit out a large Dax correction. This represents a trading strategy that differs from the approach described above, but would be plausible as far as risk management is concerned if the trader operates with 4,000 euros of capital and for whom 400 euros therefore only equates to a 10% risk.
What should be taken into consideration with CFD trading?
The CFD leverage
The CFD leverage represents the ratio of the CFD price change to the share price movement. If the CFD costs 100 euros and the Dax is at 10,000 points, the leverage is 1:100. If the CFD costs 50 euros, the leverage would be 1:200. This leverage effect can turn out to be enormous, which allows for huge profits but also rapid losses to be made. If the CFD is leveraged at 1:200, with a movement of 100 Dax points a trader can earn up to 200 per cent - with every extra Dax point, the CFD increases in value by one euro, which means a 50 euro investment would turn into 150 euros, equating to +200%. However a stop of just 10 points would mean a loss (not including the spread) of 20%, and 10 points is a short stop.
CFD margin and margin call
The margin is the deposit required in order to acquire a CFD. If the CFD costs 100 euros, the margin would be 1% if the Dax stood at 10,000 points. The margin call is an injection of money in the event that the price falls below the margin and if the CFD was not protected by a stop-loss order. The investor must then balance out their losses above that margin, which may have to be done multiple times. Example: The CFD cost 100 euros and was not protected (or the stop-loss could not resist the slippage due to an enormous price drop), and the Dax falls by 300 points. The investor would have lost their margin of 100 euros and would also have to inject a further 200 euros as per the margin call.
How to find the right CFD provider
CFD brokers should meet certain criteria. In brief:
They should be regulated by a supervisory authority.
The initial hurdle should be low. This refers to, for example, low requirements for account capitalisation.
There should be affordable access to a large investment universe.
A demo account and an extensive training scheme helps newcomers.
To conclude: our CFD broker comparison
You can find the right CFD broker by using our CFD broker comparison tool. Examine the possibilities in your own time and then make a decision based on your knowledge and preferences.