The Price of Making Money With CFD
A CFD, or “contract for difference,” is a way of betting on price changes for an asset (like shares in a company) without buying it. You’ve probably heard the term ‘derivatives’ before, and a CFD falls under that banner. It’s not a purchase of something so much as a bet on which way the price of it will move, and just as there are taxes and other costs associated with gambling, there are CFD trading costs too. These include things like commission, spread, borrowing associated with taking overnight positions and others. If you’re serious about making money with CFDs then it’s best to educate yourself and find out how CFD trading costs will impact on your profits.
The first of your CFD trading costs that we’ll take a look at is commission. That’s something that you pay with every single trade and will normally find it ranges from about 0.1% to 0.2% of the underlying value of the asset. Unfortunately, you’ll be charged both for opening a position and the closing it. (Yes, they get you in both directions!) You’ll find that some providers, who are market-makers that set their own prices, won’t sting you with commission, but they’ll still make their money by factoring in a bigger spread than others.
Spread? Yes, that’s another one of the CFD trading costs. It’s the difference between the cost of buying and the cost of selling, just like you see with forex rates at the airport. With some providers spread is bigger and with others it’s smaller.
If you hold a CFD position overnight, then it’s only natural that it will accrue daily interest (weekends included), and the rate for that will be an amount above a recognized standard rate (like LIBOR—the London Interbank Offered Rate, for instance) and you’ll quite often be charged 2-3% above this. Bear in mind thought, that the amount you pay in to perform the trade, the initial margin, doesn’t offset the cost of borrowing. Interest is payable on the price of the underlying asset. So, for instance, if you took out a long trade at $5,000, it would work out at about $0.92 a day, based on a 6.7%. interest rate. Your interest payments will also vary according to your position at the close of trade. A lower price means you pay less, and a higher price means you pay more.If you hold a short position overnight then you’ll receive interest (calculated daily) at the published rate minus a defined margin, like 3% below LIBOR for instance.
Data fees and the charge for the use of the trading platform that used to make trades is another CFD trading cost. This amount you pay for them will vary from broker to broker, and you’ll most likely pay it on a month-by-month basis. Having said that, you might find that they are willing to excuse these payments if you place a minimum number of trades each month. You’ll also pay more for setting up a guaranteed stop-loss, and that will probably cost you something near to 0.3%.
Occasional CFD trading costs (that can also be beneficial) are dividends. The thing is, even though you don’t own the underlying shares with CFDs, if you go long on a share when a dividend for it becomes due, you’ll be paid an amount that’s equivalent to a bit less than the actual dividend amount that you’d get if you did own the shares. And with a short CFD position the opposite holds true, and your account will be hit by a charge for that amount. Remember that these payments and charges aren’t issued by the company issuing the shares, but by the broker who’s providing the CFD.
If you open a CFD position, this can incur ongoing costs. CFDs are marked to market each day, meaning that their value is updated in your account. If the position is losing to start with, then a variation margin will be taken from your account, and if it keeps on losing then you could be getting a margin call, which is a demand to pay more money in quickly. Hopefully you won’t experience this, and instead you will enjoy the opposite—your position gaining and your account growing accordingly in value.
This can be a proportion of the trade size, say 0.3%, or a minimum commission such as $30, each way for trade sizes that fall below a particular amount. There are providers who don’t charge commission, but they have wider spreads not linked to the price of the underlying shares. Direct market access (DMA) is a way of directly placing trades directly onto the order books of exchanges, but they may come with different commissions, which is why it’s important to check with each CFD provider to be sure.
Instead of using the exact underlying share prices for their CFDs, some brokers use a “market made” price and they widen the spread. Some brokers will let you know the exact percentage they add to the spread, but once again it varies, so check to make sure.
Long CFD positions held overnight attract an interest charge, but for a short position, you are paid the interest instead. Long positions are usually calculated by taking the base rate and adding on a certain percentage. With short positions, it’s the opposite, so with LIBOR you could see something like plus or minus 2.4%.
To calculate today’s interest on a long position = (interest expressed as a fraction) x (1/365) x (size of the position). So if the position has a market value of $10 000, and LIBOR is at 5% (hence interest rate is 7.5% or 0.075), then interest for the day is: (0.075) x (1/365) x (10 000) = $2.05.
This is the difference between the exit price you intended and the exit price that you actually got, and it can happen if the market moves before you have actually executed a trade, perhaps due to market volatility, gapping in overnight prices, or the way that a stop-loss is executed by the market maker. It’s best to keep an eye on slippage to make sure that it isn’t happening too much. If it does happen then check that the shares you’re trading aren’t too illiquid, which can be a cause.
Some providers will charge you to use their trading platform and for how much data you use but completing of trades and you may be forgiven these costs. Some brokers may even be open to negotiation on the cost of commission and spread widening, so it can pay you to shop around when you’re looking for a broker.