CFD Brokers Explained
CFD brokers specialise in providing contracts for differences trading via mobile and web trading platforms mostly to retail investors.
CFDs (contracts for difference) are a financial derivative that is traded OTC (over the counter, off-exchange trading). That means that all of your transactions are never being routed to any exchange but rather you're engaging in a contract where you agree to exchange price differences either up or down with your broker as your counter-party.
In short words, in most cases:
- When you profit, your broker makes a loss.
- When you lose, your broker makes a profit.
This is fine as long as you're trading with a high quality and reputable broker (such as the ones we choose to display on our website).
High quality brokers never focus on a single client but rather hedge the global exposure of their company into the real market, here's what that means:
If there are $40 million in long positions and $20 million in short positions (both of them in Gold), the broker has the choice to do the following:
- Hedge themselves in the real market (cover themselves) by purchasing the real underlying asset to compensate if they believe their clients will make a profit.
- Take the risk of not hedging because they believe their clients will make a loss.
In either case, the broker is not targeting or communicating with individual traders, they're just analysing the whole exposure in their open trades and acting based on that.
Advantages Vs. Disadvantages of CFD Trading
CFD trading provides great advantages such as: low margin requirements due to high leverage factors, execution regardless of liquidity and the ability to go short (bet against) at a very low cost. On the negative side CFDs carry overnight costs when trading on leverage and they are subject to conflicts of interest between traders and brokers.
|Low margin requirements||Overnight fees when holding leveraged positions more than a day|
|Potentially better execution as it doesn't depend on market liquidity||Conflicts of interest between traders and brokers|
|Shorting any asset at a very low cost|
When choosing a CFD Broker one of the most important things we must look for is their regulation.
Financial regulators are governmental institutions that regulate the behaviour of brokers and serve as a middleman to deal with any possible disputes.
When your broker is regulated, they have to abide by the code of conduct set by the regulator and any mistake could cost them their license.
Some of the world's most recognised financial regulators are:
- SEC (Securities and Exchange Commission) - United States
- FCA (Financial Conduct Authority) - United Kingdom
- BaFin (Federal Financial Supervisory Authority) - Germany
- CMNV (Comision Nacional del Mercado de Valores) - Spain
- Cysec (Cyprus Securities and Exchange Commission) - Cyprus
Trading with a regulated broker gives you a major edge in terms of safety and peace of mind yet you should never assume that just because a broker is regulated they are 100% good.
Many bad businesses obtain licenses from financial regulators to perform unethical business practises and defraud customers. As soon as the regulator catches up with their activities, they get shut down and proceed to acquire a new license through a third-party that most probably cannot be linked back to them.
In order to prevent choosing the wrong broker, pay attention to our next point were we mention the key differences between those who practise good and bad business.
Differences Between Good and Bad Brokers
Choosing the right broker can be a complex task if you're not an industry insider full of experience and information. To help our visitors with this problem we prepared a simple table with a few points to look for when analysing your current or future broker.
|Good Brokers||Bad Brokers|
|They don’t provide any type of advice (they never tell you what to buy or sell)||They provide financial advice in an illicit way (telling you what to buy or sell)|
|They don’t call you constantly to ask for money||They call you non-stop asking for money and resort to high pressure tactics|
|They are regulated by several financial regulators||They are either unregulated or regulated by a single low reputation financial regulator which allows their wrongdoings|
|They hedge the global exposure of all their client trades and never focus on one specific client||Their office location is usually false (for example: small tiny islands on the Caribbean)|