Perhaps it’s not surprising that some traders get confused by the charges they incur when trading CFDs. It is not that the charges are complicated, but they vary from broker to broker and from market to market. As you can get CFDs on practically any financial asset you can think of, that makes for a lot of variations.
There are three basic ways in which you are charged when trading CFDs, and we will discuss each separately. There is the hidden charge which comes from having a “spread”, that is a different buying price and selling price; sometimes a straight percentage commission charge, based on the value of the underlying securities; and a daily interest charge levied each day that you hold the CFD position overnight.
First, the spread, which is the difference between the ‘bid’ and ‘ask’ prices. The fact that there is a spread means that your trade must move a certain distance in a positive direction before you could even sell it back for what you paid for it. It is usually not large, but certainly worth comparing when you are shopping for a broker. Some dealers will say that their trading is commission free, but then quote wider spreads to make up for it, so you must consider the whole package when deciding where you will place your business.
The commission charge is quite common, and may be about 0.1% of the value of the underlying security when you trade in or out of the position. Some brokers will charge up to 0.25%, but even then trading CFDs attracts a lower commission than trading the actual stocks. Typically, you will not have a separate commission charged if you are trading indices.
All CFDs have a daily interest charge levied whenever a position is held overnight, and this is usually applied at a previously agreed rate linked to LIBOR or some other interest rate benchmark e.g. Reserve bank Rate in Australia. As a derivative, a CFD is in effect borrowing on margin, as you do not have to pay more than a fraction of the value of the underlying. The daily interest reflects this cost. The interest is set to a certain amount, commonly 2%, over a published standard rate such as the LIBOR.
If you choose to take a short position instead of a long one, which can be done easily with CFDs and means you profit from a fall in value of the underlying, you may actually receive interest for the value of the trade. This is paid at a rate of perhaps 2% under the LIBOR rate, so it is not a major bonus, but still nice to have.
There is one other charge that you may find levied against you, and that is for a share dividend, if you happen to have a short position in a share CFD when the dividend is due. If you hold a long position, you receive most of the value of a dividend, perhaps 90%, but if you are short your account will be debited 100% of the dividend cost. If you are familiar with shares you will know that usually share values vary around dividend time to reflect the payment, so this may not be as large a penalty as it seems.
Traders in CFDs are also required to deposit a certain amount of margin as defined by the CFD broker or market maker (which usually ranges from 5% to 30%). The considerable advantage of this to investors is that they don’t have to put as much money as the full notional value of the contract for difference is that a small quantity of capital can control a much larger position, amplifying potential returns or losses. On the other hand, a leveraged trade in a volatile CFD can expose the buyer to a margin call in a downturn, which often leads to losing a substantial part of the assets.