Understanding how CFD Providers Work
- The golden rule with CFDs, as with all other financial products is to know the instruments you use to trade and their providers. It is a good idea to have a close look at the products before you sign up to trade them. Knowing the provider is as important as knowing the product and you may have to shop around, trying several, before you find one that suits you.
- The CFD provider acts as a market maker and provides the liquidity in CFD products. They are thus making the market and they are also your broker, which creates a potential conflict of interest. With a market maker there is as much as liquidity as you can get with your capital limits at a given price, although prices should track the price movement of an underlying so this shouldn't be a problem.
- Rumor is many of these over-the-counter/'bucket-shop' providers shake you out and take your money, well so do the specialists on the NYSE, so welcome to trading...
- CFD providers compete with each other in several areas such as cost of trading (commissions and bid-offer spread); selection of products covered (shares, commodities, forex pairs); features of their trading platforms, which can greatly enhance the trading environment; and ease of execution. They also compete on the provision of software, market data and education services.
- Most CFD providers also offer a package of services, which include such features as charting and research tools, to their clients but you may only get a basic form of these unless you pay a subscription or undertake a minimum number of trades a month (in most cases only only one or two).
- I have several CFD accounts; some with the largest providers and have never once got ripped off, except by myself by not sticking to my plan on a trade!
- Do keep a watchful eye on trading costs as these may not always be obvious - especially the size of the bid-offer spread and daily rolling financing costs for CFD positions held overnight (which shouldn't be in excess of 2.5% above Libor). Even if online CFD providers' costs are somewhat lower than those of conventional brokers, these can still add up, especially if you do a lot of buying and selling. Some providers also have a number of other fees and charges that should be studied closely.
- Don't base your decision about which CFD broker to use purely on which one provides the lowest margin requirements - you generally don't want to be so highly leveraged that this becomes so much of an issue.
- Whichever broker you ultimately choose make sure to familiarise yourself with the trading platform. It is pointless waiting until you have open trades and the markets start moving before you try to find out how to place or adjust a stop-loss level or take-profit order. You need to be familiare with the platform workings, and be able to open, close or adjust orders without having to look up the user guide.
- Be prepared for extreme situations - for instance what would happen if your internet connection were to fail and you are unable to access the online trading platform? For this reason it is sensible to keep note of your CFD broker's and account managers phone number written down near your computer.
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