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There are many different types of CFD brokers and each type caters to a very specific audience without much cross over. Here’s a quick breakdown….
Retail (Private Client CFD Brokers)
The majority of private traders will fall into this category. CFD brokers provide access to stocks, commodities, indices, FX and fixed income market through CFDs.
The main advantage trading CFDs on stocks instead of physically buying them is that you can use leverage to increase your exposure. A stock with a deposit margin of 10% for instance would enable you to buy (or short) £10,000 worth with only £1,000 on account. CFDs for private and retail traders are generally used for short term speculation rather than investing in the long term. You also have the ability of going short, meaning you can speculate on the price of a share going down as well as up.
The disadvantage of this of course is that as exposure increases, so does risk. By using leverage to trade it is possible to lose your entire account balance with just a 10% movement in the share price. As such the regulators are looking to put limits on the amount of leverage private clients with limited experience have access to.
CFDs are generally not a good tool for longer term positions as there is an overnight financing charge (as the broker is essentially lending you money to fund your position) of around 2.5% over the LIBOR rate. So holding a position any longer than a month or so becomes less economical than paying the stamp duty (0.5%) on normally stock broking purchases.
Private client CFD brokers like IG, Spreadex (Read our Spreadex Review…) and City Index, are execution only which means you have to make your own trading ideas. There are a few advisory CFD brokers around, but these should generally be avoided as brokers work on commission so have a vested interested in their clients trading more so may provide advice.
Most retail CFD broker will earn revenue from clients by either widening the market spread or not hedging client positions.
DMA (Direct Market Access) CFD Brokers
For more experienced CFD traders getting direct market access is an essential for trading. DMA, or direct market access mean that you work your orders direct on the exchange order book rather than trading from a CFD brokers widened price.
The main advantages of trading with DMA are that you get better prices because you can work limits inside the bid/offer. However, you are charged commission on trades, so must factor this in as an extra cost to your P&L.
DMA is also essential if you are a particularity big traders. Even in FTSE 100 stocks there is often not more than a few hundred thousand pounds worth of stock at the market price. If you are buying or selling a large position being able to nip away at the best price or work automated orders to drip feed your trades into the market are essential. This is called level-2 pricing and also shows you the market depth allowing you to execute orders more efficiently.
Institutional Contracts For Difference Brokers
For hedge funds, family offices or professional traders it institutional CFD brokers like Valbury Capital provide online execution platforms and experienced voice brokers to handle large orders than need finessing in the market place.
The key advantage for hedge funds using CFDs are a trading tool is that they provide anonymity as you don’t actually own the underlying assets of a CFD. You are just entering into a contract based on the different between the opening and closing price of a stock.
This what how CFDs were first used, and have gradually become available to private traders. For hedge funds and family offices looking for an institutional CFD brokers you can compare prime brokers here using our interactive prime broker finder tool.
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