CFDs, or contracts for difference, involve entering into contracts with CFD brokers where either you or the broker will profit and the outcome of the trade will be settled in cash between you and the broker.
In order to place a CFD trade, it is not required that the order ever be placed in the market, only that the broker offers the trade and will cover their side of it as needed. While this may seem to be alarming to some, this actually represents a more efficient way to place trades than actually sending them to the market and having the other side of the trade taken by third parties.
There are actually several benefits to trading this way, and one of them is simplifying the way that orders are processed and filled.
Trades placed with a CFD broker are also instantly executed, being confirmed in mere microseconds, because the trading platform is the market essentially.
When you place a market order with a CFD broker, the execution time is only limited by how fast the order reaches them over the internet, which is very fast indeed. Their system will then fill your order from their order book directly, and send you back the order confirmation with the same lightning speed.
This is actually a bigger deal than it may appear, given that in normal circumstances your broker sends your order elsewhere, with varying speeds and quality of fills. Modern technology has really improved the way that electronic orders are distributed and filled, but they are nowhere near the efficiency of just placing orders directly like CFD brokers offer. It doesn’t ever get better than this actually in terms of order flow.
While CFD traders still experience the potential for slippage, as markets can and do move from the time the order is clicked on until it is filled, no matter how fast, this potential for slippage is considerably greater when the order needs to be routed to various places. Depending on the route, traders may experience better or worse fills and better or worse execution times as well.
With CFD trading, you never have to worry about any of this, although this doesn’t mean that some CFD brokers will not fill the orders of clients faster than others. To the extent that this is an issue, traders always can move to better performing brokers of course.
Speed matters with trading, and greater speed means greater flexibility in one’s trading overall.
The Greater Market Access of CFDs
The benefits of better execution aren’t even things that many CFD traders are even aware of, as this is something that more sophisticated traders tend to focus on. CFD trading attracts traders of all levels of sophistication, from experts to complete neophytes, and actually ones that could not trade anything otherwise, due to the very small size of their accounts.
What does attract traders a lot though is the greatly increased access to markets. CFD brokers literally offer thousands of different things to trade, and a great many of them cannot be traded easily by individual traders or in some cases not at all.
Just about anything that you ever wanted to trade, and a lot of things you may not have ever thought about trading, is available through CFD trading. It doesn’t matter if you don’t have access to stocks in another country, or certain debt instruments such as treasuries, exotic currency pairs, or whatever, all this and more can be traded with contracts for difference.
As long as your broker has access to something to hedge your positions when desired, they can offer their clients the ability to trade in it. Large CFD brokers have offices in several countries and access to markets way beyond what any individual trader could even dream of, and CFD allows traders to take advantage of their increased market access.
The selection here is simply enormous and virtually all encompassing, offering access to cash markets, futures markets, and even forwards markets, and one can place trades in many things that are otherwise only available to large institutional traders. CFD brokers are indeed large institutional traders in fact.
CFD traders need not ever worry about what happens with their trades once they place them with their broker, because this is where the trade ends for them. This serves to really simplify matters, and what you see on the order screen is the actual book, and what you can see, you can trade, as long as the market is open for the instrument.
There are traders around the world that have longed to trade certain instruments that they have never had access to, or access would be difficult or require a separate account, or the minimum sizes may be beyond their means. CFD trading allows traders to access pretty much whatever they want.
The Flexibility of Trade Sizes
If you want to trade stocks, you generally need to be able to afford round lots, meaning 100 shares and multiples of 100. If you want to trade futures you have to be able to trade at least one contract. If you want to trade forex, they come in round lots as well, and so on.
Traditional brokers often require account minimums, and this isn’t unreasonable since you do need a certain amount of money to be able to trade at all the traditional way. It is just not efficient to place trades that are too small even if you could, because transaction costs would be very excessive.
If you are looking to buy a single share of a company trading at $50 for instance, and it costs you $30 in commissions to do it, your trade needs to gain 60% to break even, plus the spreads.
With CFDs, even a trade this small could be traded effectively, although not typically with shares, since they tend to have minimums that would be prohibitive with small trades. With other instruments though, you can trade even smaller than this, typically as small as you like really. While it would be absurd to put through a transaction this small in the so called real market, due to the costs involved, CFD brokers are so flexible that they can actually handle trades like this.
Given that there are no securities involved, and nothing of value changing hands, CFD trades are more efficient, and therefore lower cost. CFD trades, other than trading shares, are often commission free, which is even more efficient and even better.
In the case of other instruments, you just pay the spread, and some CFD brokers offer even better spreads than you would find in the actual markets even before they add on their trading commissions.
Tailoring the Trade Size to Your Needs
This is actually a bigger deal than it appears, as this allows for a maximum level of flexibility as far as trade size and trading strategies go. As far as trade sizing, CFD traders can specify exactly the size they want, allowing for the trade size to match exactly the needs of the client.
One does need to pay attention to minimums when it comes to trading shares though, and shares is what CFD brokers call stock, they can’t call it stock because no stock changes hands. If the minimum is $8 and the cost is 1 cent a share, then this requires a minimum of 800 shares to get the penny a share.
Since there is no third party involved, it doesn’t matter if it would be difficult or even impossible to put through a trade at the quantity the trader desires, because all that’s required is that the CFD broker allow it because it’s the CFD broker that is taking on the trade themselves, completely.
This is of particular benefit to newer or less experienced traders, and the leading cause by far of these traders doing poorly or in many cases losing all their money is that they are trading inappropriately large sizes for either their account size or their skill level.
There’s no need to worry about any of this with CFD trading, as if you only have $100 to trade with right now, you trade with $100, and you can do so in a way that does not expose your money to extreme risk.
This means that CFD traders can always manage risk to their heart’s content, and as important as managing risk properly is to trading in general, it is even more important with unproven traders. You want to generally keep your losses small as you learn, and CFD trading provides the unique benefit of being able to do that to the extent that one should, due to the complete flexibility of order sizes that it offers.
CFD’s Also Offer Maximum Strategic Flexibility
Another of the things that traders struggle with is coming up with strategies that are successful net of trading costs. This is especially the case with strategies that look to time markets more and involve more frequent trading.
With traditional brokers, the more you trade the more it costs, and the better results you need. If, for instance, a trader is placing 10 round trip trades a day, at $30 round turn, this is costing the trader $300 a day, $1500 a week, and $78,000 a year.
If you are trading with a seven-figure account, this might not be that meaningful, but with the account size most traders use, even those who earn their living from trading, it does. This is on the higher end, but if it only costs you $10 a round turn, that’s still a lot of money at the end of the year. If you trade less frequently, the costs will be lower overall, but not the costs per trade.
When you’re just paying the spread though, your trading costs are completely scalable, in proportion to your trade size. Traders therefore need not worry anymore about needing their advantage to be scaled up enough in terms of size to be profitable.
This also not only affects one’s potential profits but risks as well, and the lower one’s transactional costs per trade are, the less risk one needs to take on. The trading costs themselves represent a risk, and lower costs not only allow the trader to exit and re-enter more readily, they also prevent them from having to widen stop losses to accommodate the effects of higher costs.
CFD trading is therefore much more customizable to the needs of the trader. Normally, you have to conform to the requirements of the trade to some degree, but with CFD trading, you can conform the trade to your requirements instead. This represents a significant advantage.