CFD’s versus Futures

I have never traded CFDs (Contracts for Difference), but increasingly I am finding that my non-US clients have been attracted into trading by companies marketing CFD instruments. 

I say non-US companies because I understand that CFD trading is illegal in the US. I think there may be a good reason for that.

If you trade on a short term basis, you have to become paranoid about trading costs. If you are a long term position trader looking at, for example, a 90 or 100 point gain in a soybean trade, you are not too concerned about a bit of slippage on your entry, and a few dollars either way in the contract brokerage fee will not be too significant.

However, if you are a day-trader, you will be loading up with a lot more contracts looking to capitalize on just a few points of movement. Now slippage and brokerage costs are highly significant and have to be kept to an absolute minimum.

There was a time when a trader off the exchange floor had no chance in this game, but the advent of modern electronic brokerage companies has changed all that. Even though I trade from Australia, my brokerage company has very competitive fees and a platform that executes trades with minimum slippage.

Now, back to CFD companies. A little investigation showed they offer commodity trading in the grains, which is my speciality. What is more, there is NO brokerage fee on the contract, and no interest charge on long term holdings.

This seems too good to be true, but there is a catch. It is the spread.  In the real futures market I am usually trading with a half point spread, which means if I buy and immediately sell – or sell and immediately buy –  I am down half a point ($25 per contract).

However, the spread I am being quoted for a CFD is about five full points! If I go with them I have to make five points ($250 per contract) on the trade to break even.

No thank you! This could be a good deal for some trading styles, but it definitely would not suit mine. I am looking to be in and out of the market within a few minutes, participating for a short period in intraday trends. This spread would make it totally impractical.

It reminds me of the many forex brokers that popped up a few years ago offering commission free trades. Yes, they were commission free, but the spread back then was five pips! On top of that, there were interest charges payable each day you held the trade over night.

At about $12.50 per pip on the Euro contract, that was quite some alternative to commission! Give me a futures round trip commission of less than ten dollars on a currency contract, plus a nice tight spread and no daily interest charges, any day!

Nowadays, competition in Forex means that you can get two pip spreads in the major currency pairs, which is not too bad. But beware when the market moves quickly!

You see, if you trade with Forex or CFD companies, you are not in the real market. You are bidding in a market they make. They are in the real market and they make sure that they offset every position you take to their advantage. If you happen to hit a bid/ask in a fast moving market, and they can not offset it to their advantage, it will not be accepted. You will get a re-quote on the price.

The CFD may be illegal in the US, but there are better instruments available for the investor. For example, single stock futures (SSF) compete directly with the CFD and have a lower cost structure. Of course, international investors can access SSF products too.

I advise you to be very careful about assessing your trading costs before embarking on CFD trading. Carefully consider the alternative of trading in real markets with a transparent cost structure, where competitive pressure from thousands of participants keep trading costs to a minimum.

A key attraction of CFDs to investors is that they are leveraged instruments, but do be aware that there are many other leveraged financial instruments available to the trader. 

Face it, all that CFD advertising and those free seminars must be paid for by something! Believe me, day trading is a tough business. An absolute essential is to minimize your costs. Look at every investment vehicle through the cost prism before deciding which path to take. 

 

 

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