CFDs (Contracts for Difference) enables retail investors, even with small deposits, to trade several financial instruments, without owning the underlying asset.

KEY TAKEAWAYS

  • CFDs enable traders to make a profit, or loss, based on the difference between the entry and exit prices of a trade.
  • CFD brokers allow traders to go long and short on several instruments.
  • Brokers offer CFDs trading on margin, meaning, an account with 1,000 currency units can execute a 10,000 units trade with 10% margin.
  • CFD trading is popular in forex, shares, indices and cryptocurrencies.


Also, in this article, we will talk about the pros and cons of CFD trading and help you select the best CFD brokers, by pointing out the key features to consider when choosing one. But first, how does a CFDs broker works?

how CFD brokers work

Trading on financial products was once reserved to money movers, banks and other institutional traders. With the offering of CFDs trading, this exclusive club has become available also to the retail industry.

Even with a small initial deposit, retail investors can open positions on different assets, from forex to commodities, buy and sell shares of big corporations and emerging FinTech’s, and trade the volatility of the most popular cryptocurrencies. All that, without needing a digital currency wallet or a share dealing desk, and without owning the underlying asset.

    Brokers providing CFDs trading, via different platforms, allow investors to bet on an asset’s future price. The profit, or loss, will be the difference between the entry and the exit price.

For example, a trader thinks the GBP/USD quote, currently at 1.36900, might be going up this week, after passing the 1.37200 resistance level, and reach the next resistance level at 1.37800.

On the broker’s trading platform, the trader places a buy stop order at 1.37250 with a take-profit at 1.37800 (55 pips), and, as a cautious trader, the stop-loss level for this trade will be 1.36700 (also 55 pips). The order is filled by the CFD broker.

Now, two things will happen while trading the GBP/USD CFD. The GBP/USD quote reaches 1.37800, the trade is closed and the trader makes 55 pips profit. Or, the GBP/USD quotes drops to 1.36700, hitting the stop-less level, and the trader makes a 55 pips loss.

CFD Brokers - Instruments Available to Trade

The above example can be applied to a vast range of asset classes, commonly available for trading with an online CFD broker:

  • Forex pairs
  • Cryptocurrencies (Bitcoin, Ethereum, Litecoin, etc.)
  • Shares (Netflix, Amazon, Tesla, etc.)
  • Commodities (Gold, Silver, Oil, Coffee, Cotton, etc.)
  • Indices
  • ETFs
  • Options

As mentioned before, the main difference between a traditional trade on the stock exchange, for example, and a CFD trade, is the fact that the trader will never own the underlying asset. And the same principle is applied to all asset classes available via online CFD trading.

Let’s see the foremost differences in trading, for the main asset classes, with and without a CFDs broker:

Asset Class Exchanges/Markets With a CFD Broker
💲
Forex
Exchange one currency for another

No rollover charges
Trade the price difference

Rollover charges

Cryptocurrencies
Exchange one cryptocurrency for another

Crypto wallet needed
Trade the price difference

No need for crypto wallet
📈
Equities
Own the equities

Receive dividends

Short-selling not allowed

No rollover charges
Trade the price difference

Receive dividends

Short-selling allowed

Rollover charges
🌽
Commodities
Own the contract

No rollover charges

Physical delivery of goods
Trade the price difference

Rollover charges

CFD Brokers - Main Attributes

Now that we’ve cleared what are CFDs and how CFD brokers work, it’s time to learn what are the main features of trading with an online CFD broker and how to select the right one.

With literally hundreds of online brokers offering similar trading conditions, it might be hard to choose your next trading partner. In this next part of our guide, we will try to help you by illustrating what key features traders should look for on a CFDs broker.

CFD brokers features

Picking up on the contents from the image above, with all the characteristic features of any CFDs broker, we would like to make a parenthesis here and get your attention to the second point “Trading on leverage and margin”.

Online CFD brokers offer retail investors a gateway to the financial markets, and above all, the financial muscle needed to open positions, with leveraged trading.

Leverage, in CFD trading, allows retail traders to open larger positions, using less money (available margin), and therefore it can greatly amplify both profits, and losses. Leveraged trading is also called margin trading.

Leverage is a double-edged sword, that can boost potential profits... and losses.

    For example, going long on the EUR/USD pair at 1.0000 with no leverage, to take a total loss, the price must go to zero, or to 2.0000 to double your investment. When trading CFDs using a 100:1 leverage ratio, a price movement of 100 times less will produce the same profit or loss.

Since 2018 that regulated brokers in Europe are obliged to display on their websites the percentage of traders losing money (and in some cases, the complete loss of capital). The numbers are not very encouraging, between 77-91% of retail investor accounts lose money when trading CFDs, forex, and spread betting.

So, even before looking for an online CFDs broker, please consider the importance of understanding, and trading, how leverage and margin works. Perhaps a quick visit to our What is Leverage in Forex article could help you with the right answers. 

Best CFD Brokers Key Features

CFDs trading, and specifically margin trading, accounts currently as a sizeable portion of the world's largest financial market, the foreign exchange market.

Retail investors, lured by the prospective gains on offer, and convinced that trading the markets is an easy task, are the fastest growing segment. Thus, no wonder the growth of online brokers offering CFDs trading. But not all brokers are the same. The key features to look for on a reputable CFDs broker are:

Key Features Best CFD Brokers Other CFD Brokers
Client Money Held on Segregated Accounts
Investor Compensation Fund
Negative Balance Protection
Trading Education (webinars, market analysis, etc.) 
Competitive Pricing (spreads, commissions, deposit and withdrawals fees)
Efficient Customer Support

Finding an online CFDs broker with a flashy website, promising 0 pips spread on major pairs, and low commissions, is very easy, and one might be tempted with opening an account.

But if that online broker does not make clear what supervisory body (if any) regulates their company and activities, if the most basic investor safety mechanism (Negative Balance Protection) is not offered, then our suggestion would be a pass.

To cut through the hundreds of brokerage choices and options out there, it might be helpful to undertake the process of elimination. To find out more take a quick look at our How to Find the Best Forex Broker: 7 Key Factors to Consider complete article, where we illustrate the criteria to help you choose a reputable broker.