When looking for a CFD broker and platform, there are a number of things that need to be considered.
First and foremost, you need to consider the reputation of the broker in terms of how long they have been operating for, who they are backed by, and their standing in the sector. Unfortunately there are always going to be suspect operators that crop up, so it is important that you do some research and go with a trusted name. Hopefully this article will give you some guidance as to what to look out for when selecting a CFD broker.
Outside of the CFD broker’s reputation, you need to ensure that the instruments that you are interested in trading are in fact available on the trading platform you choose to go with. This should be the first question when asking ‘which CFD broker will I choose?’
Many people starting out in CFD trading will only be interested in trading things they are familiar with, namely, Australian equities. Even in this instance, however, certain brokers and platforms will be better than others in terms of what they offer. Some platforms are quite restrictive in terms of the number of share CFDs they offer, limiting themselves, for example, to the top 50 or 100 ASX stocks. If you are interested in trading smaller cap or more speculative stocks, however, you will need to find a platform that offers a greater range of share CFDs. Some platforms offer upwards of 500 Australian share CFDs.
Aside from shares, many investors and traders are looking to gain access to more exotic markets, such as currency and commodity markets. Those looking to gain exposure to gold or oil, for example, will need to ensure that the CFD broker they choose offers these instruments.
The next consideration when choosing a CFD broker involves fees and commissions. There are a number of ‘costs’ involved in CFD trading which traders and investors need to be aware of.
Commissions, just like those paid to a share broker, are the costs incurred when a transaction, such as a purchase or sale, is made. Much like share brokers, there is a vast difference between the cheapest and most expensive CFD brokers. Typically, competitive CFD brokers will charge no more than 0.1% of the position size, or, a minimum of between $8 and $10 per transaction, whichever is greater. So how does this work in practice?
Let’s say you want to take a $6000 position size in the market, in BHP.
On a 0.1% commission rate, the commission on this position size would be $6 (0.1% x $6000 = $6). As this is less than the $8-$10 minimum, however, the broker would instead charge $8-$10.
If you instead wanted to take a $12000 position size in the market, the commission would be $12 (0.1% x $12000 = $12).
The cheapest commission rate we have seen in the industry is 0.1% for regular traders, or 0.8% for traders who turnover high volumes. In our opinion, no one should pay any more than 0.125% for brokerage.
Although it doesn’t seem like much of a difference, excessive commissions will add up over time and could mean many hundreds, if not thousands of dollar difference over the course of a year and beyond. Remember, this is money that could be better off in your pocket, if not your trading account!
The other part of the fee structure when it comes to CFDs is the interest charge. Because CFDs are a leveraged instrument, essentially what takes place when taking a position is that you put up a deposit, known as the margin requirement, and the CFD broker puts up the rest.
Let’s again consider the $6000 position size in BHP from the previous example, and let’s assume that BHP has a 10% margin rate. This means that you only have to put up 10% of the $6000 which, of course, is only $600. The CFD broker puts up the remainder of the money, which you essentially borrow.
Like with any other financial institution, when you borrow money from a CFD broker you be charged an interest charge on the monies borrowed.
The most competitive rate that we are aware of in the industry is the Reserve Bank Cash Rate (currently 3.25% as at 31/10/09) plus 2%. Less competitive rates may be as wide as the RBA rate plus 2.5%, or even 3%. Anything more than 3%, as far as we’re concerned, is simply too much.
As with the commission rate, although it doesn’t seem like there is much difference, it can and will add up over time if you choose a CFD broker with too high interest charges.
Another key consideration when selecting a CFD broker is whether the broker offers Direct Market Access (DMA) or a Market Maker (MM) model.
Generally speaking, a DMA broker will mirror the price and liquidity that is available on the exchange over which it is providing a market. For example, if we were sitting at the ASX and watching stock XYZ being traded at $30, that is the price that would be quoted on the DMA platform.
Other features of DMA platforms include:
- No extra spreads
- The ability to be a price taker and price maker
- The ability for clients to take part in the opening and closing market auctions
- Straight through processing
DMA brokers, in theory, should make no profit directly from performance of their clients. This is because they have a hedging methodology. DMA brokers are simply the framers of the market, who facilitate the ability to trade CFDs.
The Market Maker model works a bit differently and is characterised by the following features:
- Does not always quote the same price as those quoted on the underlying exchange
- There is potential for additional spreads and potential requotes
- Market makers are price takers only
- There is no ability for client to participate in opening and closing market auctions
As MM brokers have an alternative hedging methodology, there is the likelihood that they will profit directly from the performance of clients’ positions. That is, they have a vested interest in how whether a client makes or loses money, coupled with the ability to manipulate prices. Call us suspicious, but that sounds like a recipe for trading account destruction.
Furthermore, our experience has led us believe that some MM brokers can and do charge certain clients one particular price, and other clients a completely separate price, for the same instrument. As far as we are aware, this is to benefit those clients that have bigger accounts, at the expense of those clients who have smaller accounts.
Whilst there is nothing illegal about any of the practices outlined above, trading can be hard enough as it is without your CFD broker manipulating prices and giving preferential treatment to other clients.
As such, we would much prefer to use a CFD provider that offers a DMA platform. As always though, you should always consider your own situation and needs, as well as read the individual brokers’ Product Disclosure Statements (PDS) before making a final decision.
The final considerations when selecting a CFD broker aren’t quite as important but can still make a difference to your trading. It involves a platform’s reliability and functionality. Since CFD brokers landed on Australian shores around 10 years ago, their trading platforms have come along in leaps and bounds. Indeed, all of the trading platforms we have had exposure to have been serviceable but, of course, some are better than others. Although difficult to assess at the beginning, once you have begun trading you want to make sure the trading platform that you are using is not prone to crashing, and that the functionality of the platform includes standard features such as good live price charts with technical indicators and news feeds.
At the end of the day, the CFD market is so competitive these days that there should be a CFD broker out there that can cater to all of your needs and provide a quality service. Our advice is to be picky and don’t settle for a service that is less than what you demand.
As always, may your trades be winners and your profits be large.
Happy trading.