Contract for difference (CFD) trading has become increasingly popular among retail traders in recent years. CFDs allow traders to speculate on the price movements of underlying assets like forex, stocks, commodities, and indices without owning them.
CFD brokers have certain advantages over traditional brokers for small-cap traders. However, they also come with some unique risks that traders need to understand before opening an account. This article provides an in-depth comparison of CFD forex brokers and traditional forex brokers, highlighting the key factors small-cap traders should consider.
Leverage
One of the main appeals of CFD trading is the high leverage offered by CFD brokers. Leverage allows traders to open much larger positions with a small upfront deposit.
Most CFD brokers offer leverage between 1:30 to 1:500 on forex pairs. So for every $1deposited, traders can control a position worth 30 to $500. In contrast, traditional forex brokers in the US can only offer a maximum leverage of 1:50 due to regulations.
Higher leverage seems attractive as it can magnify profits. However, it also exacerbates losses if the trade goes the wrong way. Traders need to use leverage judiciously based on their risk appetite. Overleveraging increases the risk of margin calls and blowing up the trading account.
Spreads and Commissions
CFD brokers make money through the spreads and commissions charged on trades, similar to traditional brokers. Spreads refer to the difference between the bid and ask price.
Generally, CFD brokers tend to offer more competitive spreads, averaging 0.4 pips to 1.5 pips for major currency pairs. There are even some commission-free CFD brokers. Traditional brokers usually have higher spreads in the range of 2 to 3 pips.
When it comes to commissions, CFD brokers either charge a small commission per trade or no commissions if spreads are marked up. Traditional brokers focused on active traders who charge commissions up to $5 to $10 per lot traded.
So, CFD brokers have an edge when it comes to lower trading costs, which makes frequent trading more feasible for small-cap traders.
Execution Quality
The quality and speed of execution of orders are very important, particularly to short-term traders. Both CFD and regular brokers use third-party liquidity providers to fill out orders.
The majority of regulated CFD brokers have connections with tier-1 banks and liquidity providers to guarantee ultra-low spreads and instant execution without any requotes. Traditional brokers provide the high execution quality as well, particularly in case they are the market maker.
All in all, the execution of orders by both CFD and traditional brokers can satisfy the forex traders as long as they are regulated. Before choosing a broker, traders need to verify the execution statistics, such as slippage.
Range of Assets
CFDs allow traders to speculate on thousands of global markets, from stocks, commodities, indices, to treasuries. Leading CFD brokers offer 100+ currency pairs alongside other assets.
On the other hand, traditional forex brokers focus mainly on the major and minor currency pairs and cross-currency pairs. Their asset scope is limited in terms of stocks, indices, and commodities.
For traders interested in diversifying into other instruments, a CFD account provides more flexibility compared to a traditional forex trading account.
Trading Platforms
To provide free trading services, CFD brokers usually provide their clients with user-friendly trading platforms such as MetaTrader 4 and 5. These are loaded with sophisticated charting tools, indicators, and back-testing capabilities that come in handy in the analysis and development of trading strategies.
Similar trading platforms are offered by traditional brokers as well. However, they can accept a monthly fee on platforms such as MetaTrader. Other brokers create their platforms too, and they may not be as feature-rich as the third-party platforms.
When it comes to platforms, most brokers, whether CFD or traditional brokerages, cater well to forex traders. But CFD brokers may have an edge in terms of offering more value-added features for free.
Research and Education
Since CFD products can be complex for beginners, reputed CFD brokers put emphasis on trader education via free courses, webinars, video tutorials, ebooks, and demo accounts. Leading brokers also have an economic calendar, daily market updates, and trading central alerts for clients.
Traditional brokers also invest in education. But their research and learning resources may not be as extensive as CFD brokers since they only focus on forex compared to other assets.
Regulation and Safety of Funds
Regulation is a major concern while choosing brokers. CFD brokers are regulated in various jurisdictions like the UK, Australia, and Cyprus. Leading brokers hold licenses from tier-1 regulators like the FCA, ASIC.
These regulators have strict rules for broker capital, segregated accounts to keep client funds safe, and compensation schemes up to $85,000 per trader.
Similarly, traditional forex brokers also adhere to regulations from the NFA, FCA, and ASIC. Both brokerage types offer investor protection if they are regulated. Traders must check the license details before opening an account.
Offers and Promotions
CFD brokers run various promotional offers like welcome bonuses up to $5000, referral programs, and contests with prizes for traders.
Such promotions are not very common with traditional forex brokers since they are not allowed to offer bonuses to US-based clients due to NFA guidelines.
So, traders outside the US may find CFD brokers more attractive in terms of giveaways, rewards programs, and other benefits.
Pros and Cons
Based on the parameters discussed, here is a summary of the main pros and cons of each brokerage model from a small-cap trader’s perspective:
CFD Brokers
Pros:
- Higher leverage up to 1:500.
- Lower spreads and zero commissions.
- Wider range of tradable assets.
- More trading platform features.
- Extensive education resources.
- Lucrative promotions and bonuses.
Cons:
- Overnight and weekend swap fees.
- Complex tax reporting.
- Underlying assets not owned.
- Counterparty risk.
Traditional Brokers
Pros:
- Lower risks due to lower leverage.
- Owning the underlying asset.
- More straightforward tax reporting.
- Tight spreads and regulation.
Cons:
- Limited tradable assets.
- Higher commissions.
- Lower leverage restricted to 1:50.
- Fewer promotions and bonuses.
In summary, CFD brokers provide higher leverage, lower fees, and flexibility to diversify across markets. But traditional brokers have simpler operations and reduce risks for traders.
Factors to Consider
Here are some key considerations for small-cap traders while choosing between the two brokerage models:
Account Size. For account sizes below 2000, the CFD model allows taking positions across various assets. Direct market access may be better for accounts above 10,000.
Risk Appetite. Aggressive traders focused on high leverage and risks can explore CFD trading. Conservative traders looking for lower risks are better off with a traditional forex broker.
Portfolio Goals. A CFD account makes sense if you want to trade forex alongside stocks, commodities, and indices in a single platform. Focus on forex only – traditional account fits better.
Regulation. Always verify broker licenses, compensation schemes, and years in business before opening an account with either a CFD or a traditional broker.
Overall, CFD brokers seem to have an edge over traditional brokers when it comes to the needs of typical small-cap traders focused on lower costs, flexibility, better leverage, and promotions. But the higher risks must be clearly understood.
Conclusion
The CFD derivatives have been a low-cost and easy means through which small-cap traders have been able to exploit the volatility of the forex and global markets. The CFD brokers have greater leverage and lower fees, but the risks are also increased.
Using the comparison of the main aspects revolving around leverage, spreads, safety, and flexibility, small-cap traders are able to make informed decisions between CFD and traditional brokers, which fit their trading style and risk tolerance. It is crucial to educate yourself on risk management to live in a fast-moving environment of currency and other instruments, CFD trading.
