Costs of Trading CFDs
I am sure most of you are aware that rarely do you receive ‘something for nothing’ and CFD brokers are a prime example of the invalidity of this phrase.
Some brokers will charge a monthly fee to use their CFD Platform. Some will only charge for use of their research information, while some will provide free access to their platform. Differences in the volume, type and size of your trades, will determine what broker to choose. Usually free brokers will have looser bid/ask spreads, so a comparison between brokers is essential before choosing a platform.
Most CFD Providers will charge a commission on trades, this usually ranges from 0.1%-0.5% plus a minimum fee for smaller trades ($5 or $10). This is considerably cheaper than most securities brokers and is well deserved too. With minimal regulation and only one transaction (between you and your provider) costs are minimal as opposed to trading a stock where it must pass through a large electronic exchange and audit stream in order to change hands.
Some brokers offer ‘commission free’ trades, but there are usually hidden costs as can be seen below.
The Spread can become costly when trading on a Synthetic Market with Synthetically priced CFDs. Synthetic Pricing relates to how your CFD broker creates the bid/ask spread for any particular CFD. This will usually start with the broker examining the underlying asset then running it through a predetermined system of policies and rules to output an inflated spread. For instance, if the underlying ask price of a stock is $20.00 (on the securities exchange) your broker may choose to sell it to you at a price of $20.05. This is a fairly simple concept to understand but it is easy to see the costs that can add up over time. If the broker makes $0.05 on every CFD you purchase, a position of 1000 shares will equate to $50. If you add commission of 0.01% on top you are looking at $60 in costs as opposed to $10. Most brokers aim to provide a tight bid/ask spread and DMA providers provide a perfect spread increasing the fairness to traders.
Be warned, this is how the ‘commission free’ brokers make their money. They provide a loose bid/ask spread, charging you every time you enter or exit a position (relative to the underlying market) which can equate to much higher fees than the commission charging brokers.
Since CFDs trade on a margin, you are borrowing money to complete the trade. Now we all know borrowing money isn’t free, as is the case with CFDs.
The difference with CFDs is that you can avoid financing by getting out of the trade in the same day as finance charges only occur on positions held over night. Since CFDs usually trade on 100% borrowed money (as the margin is merely a deposit on the loan) positions held over night are charged accordingly. Financing on CFDs is usually calculated at a few percentage points above (for long positions) or below (for short positions) as the countries underlying cash rate. Thus if the cash rate is 5.5% pa you will usually be paying 7.5%pa for long positions and earning 3.5%pa for short positions.
Going long will incur a financing charge calculated at the ‘discount rate/365 days’ (0.075/365) which is charged daily in cash.
If you short sell a position, you earn interest over night which uses the same calculation bar a cheaper rate (0.035).