MoneyAM Shares Magazine

Doing business with a CFD Account

Jones: Right, let's get on to nuts and bolts. I've opened my CFD account, I've put some money in it and I think: 'the market's rallying, George Bush in back in for four more years, I'm going to buy some Vodafone because its going to go up'. Is it as simple as saying 'I'll buy 1,000 CFDs'? Or is it a bit more complicated?

Tom Hougaard, City Index: No, it's as simple as that. We need to ask you a few questions to make sure you understand exactly what CFDs are and what margin trading means. Once this is done and your account is open, you're free to trade.

Zak Mir: All of our clients need to prove they have sufficient experience to trade CFDs. Once the account is open, you can trade via the phone or online. The dealers are all experienced and most have appeared in the national press - no guarantee of making money - but each dealer has a limited number of accounts to look after. In a fast market, you need to know your broker will not be tied up with another client.

Zak Mir - Chief Market Strategist

Jones: I think another reason people are a bit wary of getting involved in CFDs is they think they are complicated, like covered warrants and options where you have a time premium built in and you'll buy one contract that covers so many thousand shares. It's that straightforward.

Zak Mir: And there's no time period by which they have to get out of that position.

Jones: That's another good point. So if we really want to, we can hold on to our CFDs for ever in most circumstances.

Tom Hougaard, City Index: I always point out to people that from a price point of view you can't tell the difference between a CFD and the underlying share. You won't find two kinds of Vodafone to trade with one being the physical share and the other the CFD.

Jones: Let's say I've got my Vodafone shares, I think they're going to go up and I'm planning on holding them but over the course of the next six weeks these shares are going to go ex-dividend. What happens?

Geoff Langham, CMC: If you are long the stock then you receive the dividends on CFDs and if you short the stock then you pay the dividends. The price the following day will adjust for the price of that dividend as it will in the underlying market. There's nothing more to it than that.

Nick Sparkes, GNI touch: You can expand that to corporate actions too - it's generally the same whether you're holding the CFDs or the shares, except for the voting rights.

Jones: So if for example there was a 10-for-one share split and it went from £2 to 20p, you would have more CFDs.

Tom Hougaard, City Index: And the same applies to rights issues as well.

Jones: The mechanics of it sound straight forward enough. As far as clients are concerned, it's the same to all intents and purposes as buying the real shares but with extra advantages.

The mechanics of it sound straight forward enough. As far as clients are concerned, it's the same to all intents and purposes as buying the real shares but with extra advantages

Now I want to choose which company to trade through. There are companies which charge commission to trade and there are those which don't. What are the pros and cons of both approaches?

Nick Sparkes, GNI touch: At GNI, we give our clients direct market access and effectively they are up there with all the institutions putting their own prices into the real market. For that sort of privilege we charge a commission which is a percentage of the underlying transaction.

Beware of the spread. The person who is doing the deal for you has to make a living - we're not there for free, so check the spreads out.

Tom Hougaard, City Index: City Index charges a small commission on our CFD trading. We have an award-winning trading platform that allows our clients to execute their trades instantly. Many of our competitors don't have this 'instant execution' facility, which means their clients often don't get the prices they saw on the screen. In other words, the low dealing charges or even free trading can mean a worse execution price than elsewhere.

Another two very important points that potential CFD traders should consider when weighing up the pros and cons of the various CFD providers are price execution and,'segregated funds'. When you sign up as an 'expert user', as you do with many of our competitors, you waive the right to get the best possible price in the market and on top of that your funds are no longer held in segregated accounts. That is not the case with City Index, which lets the clients execute their trades at the open-market price without giving you an 'alternative' price, also known as a 're-quote'.

Traders and investors should also look carefully at how much the CFD provider charges in overnight funding as this varies from company to company.

We also have Level 2 data for those people who are more active, plus a very advanced charting package, all free of charge.

Geoff Langham, CMC: As the name suggests, at deal4free.com, which is owned by CMC, we don't charge commission on CFDs or spread betting. I invite anyone to come on to our website, sign up and view our spreads - they are the same as those offered in the underlying market.

Tom Hougaard, City Index: If you execute at the market and you don't charge commission, how do you make money?

Geoff Langham, CMC: We count on the spread, as small as it is, to provide some income. We also aggregate our trades and risks - match them off one customer against another, one sector against another, one country against another, and use a portfolio hedging strategy which relies on options and futures trades that are ultimately cheaper to deal in than shares are with a broker.

Zak Mir: We, as an advisory brokerage company charge commission. The difference with us is that we advise you on what to buy and sell and how to survive in the market. There's no point trading with a minuscule spread and great prices if you do not know when to click the buy and sell button, and our aim really is to help people make money.

Nick Sparkes, GNI touch: That's exactly what we do - there's a group of people on the desk at GNI who are brokers and advise clients. We've got on average 15 years' experience per person.

Jones: From the user's point of view, there is no law against having three or four CFD accounts, so I think the answer is to try everybody and find a provider who suits your style of trading.

Make it easy for yourself

Jones: Let's move on to controlling risk. Our client now fancies the idea of using CFDs but the leverage thing together with the market volatility we've seen over the past few years is a little bit scary. He doesn't really want to sit stuck to the screen all day watching all the numbers flash. Is there a way you can make his life easier?

Zak Mir: What I do at my advisory brokerage company is come up with buy and sell recommendations every day. I choose the stocks I think represent a good cross-section of the market. If people don't like a stock or are worried about it moving too much against them, I will choose a stock that is not too volatile. For instance, I might suggest they buy Lloyds rather than Barclays if they think the banking sector is going up, or buy the sector itself. It's that sort of tailor-made approach.

Jones: Do your clients trade on their own initiative at all?

Zak Mir: They might say 'I think Lloyds is a sell' and I'll say 'actually I think it's a buy'. They can come up with their own conclusions. But I always have on-tap recommendations for the day which people can choose.

Jones: But if I wanted to buy Vodafone.

Zak Mir: You are perfectly entitled to and I wish you good luck.

Jones: And if I want to buy it for 2p less than it's currently trading, can I put an order in and it just happens?

Zak Mir: Yes.

Jones: Is it similar at GNI - can I do limit orders where I buy if the stock goes a bit low? And stop losses?

Nick Sparkes, GNI touch: Limit orders have always been run of the mill. These are orders that are resting behind the market - buy orders lower than where the price is now or sell orders higher than where the price is. You can use stop orders but I always try and persuade our clients away from giving stop orders and to phone up their account handler or broker. Everybody has an account handler whose job it is to monitor the positions of clients and I would always advise clients to give their stop level to their account handler and ask for a phone call so they can make the decision there and then, rather than having it automated and maybe having a spiked fill.

Zak Mir: That's fine for some clients sitting on the ends of phones, looking at screens. But for example, BAE Systems had an SFO warning yesterday.

Nick Sparkes, GNI touch: Yes, but if you'd got the phone call you could have come to the same conclusion that I did, which was 'hang on a minute, this isn't new news'. Then you can make a decision based on why the stock has moved. You couldn't have picked a better example, because the stock has now moved back up.

Jones: The important thing to stress is that all this stuff helps minimise the risk involved with CFD trading and means you don't have to watch the screen all day. Whether it's a call from GNI or an automatic stop loss with IG Markets, there are ways of minimising the risk with CFDs.

The safety net of the guaranteed stop loss

Jones: We haven't touched on guaranteed stop losses.

Geoff Langham, CMC: These are very simple. With a typical stop order you're not guaranteed the price that you put it in at. Were the price to gap through it then you would be filled at the first available price after it has gone through. With a guaranteed stop, it doesn't matter if it gaps or not - as long as the price has been met then the price you put your stop loss order is the price you will get.

Zak Mir: So if I had been long on BAE Systems at 2.44 and had my stop loss at 2.39, I would have been filled at 2.39.

Geoff Langham, CMC: You would have been. You do have to pay for this privilege, which depends on the price of the stock or what the instrument is. Typically the cost to guarantee your stop is 0.52p for UK share CFDs.

Zak Mir: There's no way you can have guaranteed stop losses for free?

Geoff Langham, CMC: No, but it's like having an option.

Jones: Of course the flip side applies to going short - if you're worried about the stock exploding up in your face, you can limit your losses both ways round.

Nick Sparkes, GNI touch: One piece of advice I give to a lot of clients and something I've found works very well is that if a position gets to a level where you think you should be getting out, halve the position. Take half of it out and then see what happens.

Usually first of all when you start using that method you are already half way to admitting the position was wrong and you very quickly find yourself taking the other half out and saving a lot of money. It's a way of making sure you're more disciplined.

Zak Mir: Discipline is the one thing that separates those that make money consistently and those that don't. Our view is that anyone trading without a stop loss is putting off the inevitable.

Tom Hougaard, City Index: But we say the first cut is usually the cheapest.

Jones: The thing is, Tom, you're quite a successful high-profile trader and obviously good at what you do. Lesser mortals don't have the discipline. They buy stock at £10 and it goes to £9, £8, £7. they're still there.

Nick Sparkes, GNI touch: But if they buy it at £10 and it goes down to £9.70 and it wasn't supposed to go down and they halve the position, then if it goes to £12 like they thought all along they will still be all right. If it starts edging down again they have already halved it and will just get out and move on.

A lot of people don't like getting out of trades because they often don't have another one to get into. They think, 'Well, that was how I was going to make that £3,000 and if I get out of that and I haven't got anything else to do, how am I going to make it now?' Greed is definitely one of the reasons for people not wanting to stop themselves out.

Trading requirements and the bigger picture

Jones: How much money do I need to open an account?

Zak Mir: Our advisory clients normally start their accounts with anywhere from £10,000 to £500,000. I speak to clients each day with more and less than this. It's important that you have enough funds to give you flexibility but that you are not so exposed as to compromise your trading.

Tom Hougaard, City Index: £500 is generally the minimum required.

Geoff Langham, CMC: At CMC the minimum is £2,000 to open a CFD account.

Nick Sparkes, GNI touch: Our minimum is £5,000. It used to be £10,000. My personal experience is that it's easier to start with something like £20,000 to have a good chance of being successful. But £5,000 is our starting level and you'd be surprised how quickly you can turn £5,000 into £10,000 and how quickly £10,000 becomes £20,000.

Jones: Do you think the traditional stockbroking industry has had a nudge in the right direction over the past few years with all these products coming along?

Nick Sparkes, GNI touch: Totally. Some of the business we've picked up has been at the expense of the stockbrokers. Obviously a lot of the shorter-term traders would never have done that style of trading because of having to pay stamp duty and stockbrokers' fees. But I do think there are a lot of lesswealthy stockbrokers out there because they're having to compete with commission levels that they've never seen before.

Unfortunately the downside of that may be that if stockbrokers are seeing less business, they may have to streamline, which could mean the service of your stockbroker may go down rather than up even though it may be making the whole process a bit more efficient and providing more research to its clients to keep up with the likes of us.

CFD providers have leapfrogged stockbrokers. You get much more professional handling by people who are used to working in the City. I've got 17 years of experience in futures and these are the sort of people we have hired - City people who are giving an institutional type of service for privateclient money.

Geoff Langham, CMC: Companies like ours have given very good reasons for someone to change from a traditional stockbroker. If you intend to trade in shares, futures, commodities or FX on a semi-regular basis, then you should seriously consider doing it through a CFD or spread-bet provider for the reasons mentioned - that is: no stamp duty, with us no commission, margining abilities, and the ability to go short and long.

Jones: A lot of companies now offer CFDs. We could run off a big list of CFD providers out there - it has exploded since the start of the millennium. Gazing into a crystal ball, do you think they are here to stay and where do you think the industry is going over the next few years?

Tom Hougaard, City Index: City Index is one of the market leaders in white-labelling. This means we have among our clients some of the biggest stock brokers in the country, which are using our services to provide CFD trading for their own clients. I believe we will see more banks and brokers go down that avenue because it is a very cost-efficient method for them to use an existing platform and to provide a proven high-quality service to their existing client base. If they don't, I believe in time they may lose both clients and market share. CFDs are here to stay. It is a question of educating the investment public in the advantages of the instrument.

Zak Mir: I think this exercise shows that people still need to know a lot more about CFDs, they're not mainstream at all. Going up and down the country, there is still quite a battle to be won describing what CFDs are.

Nick Sparkes, GNI touch: As long as the stamp duty is kept out of the situation, then I do think the ratio of CFDs to stock transactions held in the original owner's name is going to change over the next five years. I don't know what the percentage is now.

Jones: I think 35% was the last figure I heard - more than a third of transactions on the LSE are CFD-driven.

Geoff Langham, CMC: At CMC we also have a very strong software offering, professional charting, news, a pricing of 1,500 products on a real-time basis..

Nick Sparkes, GNI touch: I would be surprised if it wasn't 50% in another couple of years and maybe 65% in five years' time. There are a number of people out there who will be kicking themselves that they haven't been aware of CFDs. There are potential new clients out there for all of us who do not know about CFDs. Having said that, CFDs are not for people who have just decided they want to open an account and invest. That's not what CFDs or spread betting are about. It's not about investing, it is about geared trading. Some people would term it gambling, I wouldn't. The other thing is that as people get more professional and more knowledgeable about what is available, they will start to move on to other things such as covered warrants and even higher gearing with options. And finally...

Jones: To wrap up, why in a couple of sentences should people consider trading CFDs through your firms?

Tom Hougaard, City Index: People should trade CFDs with City Index because we have some of the lowest, if not the lowest, commission rates in the industry. We provide a state-of-the-art trading platform with instant execution in a size that fits you. We offer Level 2 data free of charge, which in itself would otherwise cost you £30 to £50 a month. We offer a state-of-the-art charting package which can pretty much chart you anything in the world. And it's not just stocks that we offer. We also offer indices, commodities, even FX, and always on a maximum margin of 10% with FX at 2%.

Geoff Langham, CMC: At CMC we also have a very strong software offering, professional charting, news, a pricing of 1,500 products on a real-time basis plus all the back-office reports. We are commission-free, our financing rates are very competitive, our margin rates are 1% for FX and 5% for shares. I invite you to compare these features with our competitors and make your own choice.

Nick Sparkes, GNI touch: We've got cheap commissions plus the charting packages and analysis. But I think the edge we have is the experience you will get at GNI through having an account handler with the market experience you won't get anywhere else.

There are many pitfalls when you're trading geared products that your account handler can make you aware of. If you don't have that sort of hand holding in the initial stages, then I think every now and then one of the pitfalls will trap you. Also, we do give out market advice, we do point out charting levels - all things that I think our clients like.