The Definitive CFDs Guide

If you are new into the FX and CFD trading, we provide you here very briefly with the concepts you will deal every week with: spreads, swaps, margins, execution type, minimum lot sizes, deposit and withdrawal methodologies, or compliance checks.

Spreads

The spread is the cost of facilitating you the trade, the difference between the bid and the ask.

Keep in mind that if a broker offers a very low spread or none at all, it is a very red signal that you are dealing with a B-book broker, no matter if it says on its website that it is ECN, NDD, DMA or STP - because with the spread and swaps A book brokers generate mostly all of their revenues.

How much or little the broker charges with the spread depends on the volume generated by the asset. The lower the volume an asset have (for example, the Turkish Lira against the South African Rand), the higher the spread, because the higher the cost for the A-book broker (for the investment banks that provide the liquidity) to trade on the underlying market (futures exchanges or spot exchanges).

Therefore, unlike what beginners do, make sure that the broker charges a reasonable spread to ensure that it is your main source of income along with the swap/rollover/overnight funding.

Swaps

The swap/rollover/overnight funding is the cost of holding a leveraged position overnight and is usually charged at 22:00 UK time.

The swap usually costs x3 on Wednesdays or Fridays, depending on the asset, to charge for holding the position on weekends. When you trade a leveraged product such as a CFD, the broker offers you a financing (the leverage), and charges for that "loan" some interest, and those are the swaps. Swap costs usually depend on the type of product with which you operate, although they are usually a 2.5% annual administration fee + IRR + additional costs, which in the end is usually 3% per year divided by 365 on the leveraged value of the position, and that is what is charged at the overnight level.

It should be noted that for tokenized products such as cryptocurrencies, swaps are much more expensive.

It is important to know the swaps and spreads of any CFD broker and to have in writing how they work.

Guaranteed stop losses and other types of orders

Stop losses, take profits or any order to close a trade always have the risk of slippage, which is nothing more than the difference between the price at which you placed the order to close and the price at which it finally closes due to high volatility.

Sometimes this type of inconvenience occurs because the broker of book A cannot execute your orders to the millimetre in the underlying market/liquidity provider bank and then cannot execute your order at the price. This usually happens because of a very volatile movement, due to too much volume or volatility in a specific asset.

Execution type

Our favorite.

The most important thing in the CFD derivatives ecosystem is the execution type. While you can play with STP (Straight Through Processing), ECN (Electronic Communication Network), MM (Market Maker), or NDD (No Dealing Desk), there are only 2 types of executions: the A Book (DMA) and the B book (Market Maker-STP-ECN-NDD). Of course, they can be combined in a single mode.

Trade only with A book brokers. The easiest way to know if a broker is A or B is to look at its accounts, and this is only possible if the company is publicly traded. When a broker profits from its clients' losses, there is a P&L profit section in its accounts, which is the profit it has made from the clients' losses.

When the broker is A book, every time you place a trade, they place it in the underlying market or liquidity provider bank, charging you the spread, swap and premium orders, and that is their only income.

B book or scam brokers simply trade against you and what you lose is what they make, apart from the spread and swap and additional charges.

To check whether a broker is A book or B book, the most important thing is what they say in writing, the regulatory authority, their public accounts (are they a public company?), their spreads and swaps, how long they have been trading in the industry, opening or closing their offices, deposit and withdrawal as a KPI versus volume, transient margin requirements and above all, what they do no more than what they do.

Margin requirements/leverage

The broker or its financial partners allow you to trade with leverage and the leverage usually varies depending on the product you trade as well as the volume you trade with. The higher the leverage and therefore the lower the margin requirement, the faster you will hit your stops or burn your account. In reality, statistically speaking, unless you have a lot of experience in quantitative fund management and risk management with algorithmic methodologies, any leverage higher than 1:200 is sheer madness.

Keep in mind that most banks are not going to offer you a leverage higher than 1:5 /1:3.3 for real estate acquisition and there they have the real estate itself as a hedge. How can you then trade with a leverage of 1:1000 in liquid markets? Brokers who offer these kind of products just want you to lose.

Deposit and withdrawal methodologies

By regulatory obligation, the capital of traders has to be at all times in a segregated bank account in high standing banks in the name of the securities company, and the clients' money has to go directly from their deposits to that account, and from withdrawals to their bank account in their name. One of the characteristics of stock brokers with a casino business model is the ingestion of withdrawal and deposit methodologies they offer.

Exactly the opposite is what professional traders are looking for, a broker with only debit/credit card and wire transfer as deposit and withdrawal methodologies.

AML, TFI, & KYC checks

Any financial institution with which it is very easy to open an account is not really of quality. In Singapore, it can take a foreigner up to 1 month, 3 physical meetings and at least $150,000 to open a bank account, making it one of the most prestigious places in the world to do so. In the other area, for example, in the recent Juicy Fields pyramid scam, KYC was not done.

The truth is that a broker that trades the right way will do the proper check and the amount of documentation depends on whether your regulation considers your jurisdiction (where you reside, not where you were born) High Risk, Medium Risk or Low Risk, but the check is critical and in no case can you trade without having KYC completed.

Execution speed

The broker's servers must be in a nearby location and preferably close to the trader's place of residence. The speed of execution must be very fast. In general, what a professional looks for are professionals, not pirates, and the professional is usually slower, more difficult and more expensive than low quality, but, in the long run, it catapults you to success, while piracy, to the masses.

Francisco F. De Troya

Algorithmic trading & derivatives professional.

Executive Chairman, Blockmas

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