Trading Costs are Very Important
The longer term the trade is, the less significant trading costs are, which are what you paid in commissions if anything, plus the spread and other costs associated with a round turn trade. Investors really don’t care about such things, as in the end this will represent such a small percentage of their profits or losses, and they aren’t trading very often either.
On the other end of the spectrum, day traders need to be extremely concerned with trading costs, since these trading costs are going to represent a lot larger percentage of their gross profits, and they are placing a lot more trades as well.
CFD traders are not investors, and while you can trade CFDs over a period of days and even weeks if you wish, this type of trading is not designed at all for longer time frames, because the risk involved would be way too high using any kind of real leverage.
People trade CFDs for the leverage, and this is the biggest benefit of CFD trading by far, while one could trade them with very small amounts of leverage such as 2:1 by keeping the majority of their money in cash, this really wouldn’t make a lot of sense, and one might as well trade ETFs.
CFD traders therefore will be trading actively to very actively, and this means that trading costs will be very important, and relative trading costs will be a major consideration in deciding what assets to trade.
The ability to trade commission free with CFDs, as is the case with most of the trading products offered by CFD brokers, is an even bigger advantage than most people think, especially for smaller traders. Some think that these costs will just be included in the spreads, and to some extent this is true, but variable costs instead of having a fixed cost on top of that can be a huge plus.
The reason why traders pay commission costs is that the broker needs to make money, and with traditional brokers, this is indeed how they make their money. CFD brokers aren’t actually brokers though in the true sense, they are dealers, and they make these markets, they are the ones that you are buying and selling the asset with directly.
While some brokers are greedier than others and will seek to make more money off their trades by charging bigger spreads, some are much less so and when you can find a commission free deal with good spreads, now you are really on to something.
Some brokers are able to offer some great deals here, with spreads as good as you will find with commissions added on to them, without the commissions. When you trade a lot, this can make a big difference overall.
Having all of your costs variable, in terms of a spread, makes trading fully scaleable, and you can place a trade for $1 or for $1 million and have the same percentage costs, whatever the spread happens to be.
Trading Stocks with CFDs
This is one of the reasons why trading stocks, or shares as CFD brokers call them, is often not the best way to go. Many CFD traders trade shares, and this is very popular, but it’s more that these traders don’t really properly understand the dynamics involved and how these trades affect their trading costs.
Share trading generally has per trade minimum commissions, not unlike trading stocks with a traditional broker, and while the costs do tend to be competitive with many retail brokers, they aren’t generally so competitive with other forms of CFD trading.
If, for instance, one does want to trade the stock market, one can trade the indexes instead. While indexes tend to be better behaved than the more volatile stocks, the ones people like to trade, this is actually a good thing. Iif one seeks more volatility, you can get all you want and then some, enough to hang yourself with if you want, with indexes, which can be leveraged a lot more.
Most importantly, when trading indexes with CFDs, there are no commissions generally or other costs apart from the spread, unlike futures trading for instance which do involve commissions.
Perhaps the biggest difference between shares and indexes is that indexes often trade around the clock 5 days a week, while the market for stocks closes at the end of each trading day, exposing the trader to a lot of risk of gaps against them.
Stops can be used and must be used when trading CFDs, but stops cannot protect you when the market is closed and then opens up with a big move against you. The stop will execute immediately, but perhaps not even close to the price you set as your maximum loss. With the higher leverage involved in CFD, this can be a very painful situation indeed.
In fact, protecting against these situations is perhaps the most important thing in CFD trading. Managing risk is priority one in any trading, and it’s much more important in CFD trading. You can’t always fully manage gap risk, as trading may be halted, but with indexes, if it is halted this only really happens after a big move, where you would be long stopped out already. Stocks can be halted anytime though, and can even open up with a gap against the trend it was trading in at the time of the halt, which makes them even riskier intraday.
This isn’t to suggest that one should not trade shares with CFD accounts, but one must be careful not to expose too much of one’s account to the risks involved. Other forms of trading are generally preferable as well, for several reasons.
Spread to Range Ratios
CFD traders do not need to focus on more than a few assets to trade, even one asset can be fine, like a certain type of currency pair such as EUR/USD. One can make a very good living trading this alone, and one can also be in a trade full time with this if one chooses, and do so effectively with the right amount of skill applied.
With such a wide selection of things to trade, CFD traders might be tempted to trade a lot of different things, and while this might not be a bad idea when one is learning, to experiment, this sort of thing should be done on one’s simulated account, not with real money, even small amounts.
What we are after here is seeking the assets with the better payouts. There will be a certain expected gain that we may expect from our trading system, which is of course net of the spread, and when we subtract what we have paid for the spread, we get our net gains, or losses if we’re not profitable enough.
It’s not that we always want to go with the lowest spreads percentage wise, and for instance an index may have a bigger percentage spread but move more, yielding a higher profit potential, but we’re certainly after trading assets that will deliver better multiples of the spread on average.
The spread here represents the cost to trade, you can’t make the market with CFD trading and have to pay the bid or ask, and the more multiples of the spread that you can expect to make on average, the better the asset will be to trade.
There’s more to it than that, as some assets tend to behave in a more predictable fashion, and steady movements in either direction are what we are after, and the ones that whipsaw a lot are the ones we want to avoid, as we will become stopped out too easily.
Finding the right assets to trade is somewhat a matter of personal choice, although there are considerations that always must be accounted for. How much liquidity an asset has, what the spread is, how it moves, its trading hours, its particular margin requirements, and other factors will serve to influence one’s decisions here.
One may experiment here, but having a good idea of what we’re looking for and what makes one asset better than another to trade with CFDs is a necessary foundation.
Editor, MarketReview.com
Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.
Contact Andrew: andrew@marketreview.com
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