As we’ve outlined in earlier articles in our CFD trading series, CFD trading differs from ordinary share dealing in many respects. Fees & charges are another way in which they differ.
How trading fees impact overall performance:
If you’re a trading veteran, you will already understand the significant impact that trading fees can have on day trading returns. For beginners; here is a short summary that will illustrate:
Consider, for example, purposes, a trader who successfully picks the correct price direction 60% of the time and chooses the incorrect price direction 40% of the time.
Provided that each trade only uses a modest % of total capital, the amount allocated to each trade is consistent, and the absolute % size of gains is similar to losses, you would expect this trader to be in profit. But how much profit?
Let’s ignore leverage for a moment and assume that a winning trade involves investing £100 and selling at £105, less £1 transaction fees. A losing trade involves investing £100 and selling at £95, less £1 transaction fees.
Before fees, the trader makes a £5 profit 60% of the time and a £5 loss 40% of the time. This gives an expected profit per trade of £5*60% + -£5*40% = £1. Across 100 trades, they would be £100 in profit.
However, due to the £1 transaction cost that is applied to each trade, the actual net position across 100 trades would be £0.
This example is simplistic but it demonstrates how fees impact the trading equation. A reasonable trading edge is required to simply break even. Trading profits must be used to pay fees before you can pay yourself.
This should set the context for why it’s important for traders to seek out CFD trading platforms with competitive fees. The difference in pricing between one platform and the next could make the difference between a trading edge resulting in a net profit or a loss. Every £ saved in trading fees will directly improve your financial result.
Overview of CFD fees
What follows will be a general description of how the industry-leading CFD platforms generally charge fees to investors. Different platforms will naturally use different pricing models and may differ slightly. Ensure that you read the fees and charges pages in detail on any broker website before you sign up.
Fees can be grouped into two types:
- Transaction fees
- Account fees
Transaction fees are fees levied as a direct result of you placing and settling trades.
Account fees are unconnected to your activity, and would be charged regardless of the number of trades you make per month. These will be clearly stated on the provider website and will be simple to understand, so we won’t dwell on them in this article.
When trading CFDs, the main transaction fees you may incur are:
- ‘The spread’
- Overnight holding costs
- Fees for premium trade types such as ‘guaranteed stop-loss’
The spread is the difference in the buy and selling price of a trading instrument. All CFD platforms offer a higher price to buy and a lower price to sell. This creates a loss for the trader.
CFD trading providers will quote a minimum spread value, defined as the price increment added or deducted from the mid-market price to create the spread.
Smaller, also known as ‘tighter’ or ‘narrowers’ spreads, will result in cheaper trading for clients.
Spreads vary between market and instrument, depending on the volatility and trading volume for that particular instrument.
Spread costs aren’t unique to CFD trading – they’re a feature of any financial market. Spread costs are incurred when trading shares on the stock market for example. Market makers are institutions that agree to provide a high level of liquidity in a number of securities by offering them for purchase or sale throughout trading hours. When quoting to buy they will offer a lower price than the price they will offer to sell. In doing so, they ‘buy low and sell high’ throughout the day which generates a profit at the expense of traders who take the other side of these trades.
Stock market bid-ask spreads vary depending on market conditions, so you cannot know what spread cost you will incur in advance of entering into a trade.
Overnight holding costs
CFD positions incur charges when held overnight. The exact mechanism will differ between CFD providers, so we’ll use the following situation as example:
At 5 pm New York time, any open CFD positions will be subject to an ‘overnight holding cost’.
This will vary depending on the security and whether you have a buy or sell (long or short) position. In some cases, the calculation may result in a negative charge, i.e. income from the trader’s perspective.
The cost is calculated as 1/365th of an annual rate quoted as follows at the time of writing:
Tesla Motors Inc shares
- Buy: 4.53% charge
- Sell: 1.87% charge
- Buy: 3.1671% charge
- Sell: 0.3883% income
UK 100 equity index
- Buy: 4.1911 charge
- Sell: 1.8089 charged
Overnight holding costs see traders effectively pay for the benefit of using leverage over periods longer than a day.
In contrast, spread bets are short-term bets with an expiry date. These can be rolled over into future days (effectively being renewed as a fresh bet) but the process of rolling over a bet does not preserve all of its original characteristics. For spread bets, the original bet will be considered settled and a new bet will be entered into at the ‘mid-rate’ of the spread. This halves the impact of the spread but still means you are effectively paying half the spread per day the bet is held.
Particularly if the opening price in the market has moved against the closing price – this price movement may not affect the profit or loss on the spread bet. This can result in returns drifting away from the long-term movement in a price index (read more about trading on indices).
Premium trade types
The most basic trade type you can make is a market buy or market sell order. These instruct the provider to open or close your position at whatever the prevailing market price is (adjusted for the spread) at the time of execution.
This trade type opens the possibility for the market to move in an unfavourable direction between the trader placing the order to close the position and the trade being executed. Due to leverage, the impact of such movements could be significant.
Therefore, CFD providers have created more complex trade types that allow you to specify a price that will automatically trigger a trade, such as a stop loss order that will close out a buy position if the security price reaches a defined price point. However, stop losses are not guaranteed to work and do not activate if the price of the security or jumps past your price point due to rapid movement (also known as ‘gapping’).
Some brokers rolled out a trade type called a guaranteed stop loss order or GSLO to combat this issue and provide additional risk management options to traders.
Let’s say you take out a buy position on Nike Inc stock and you wish for the position to automatically close if the price of Nike falls below $100.00. You could place a GSLO at $100 that will remain in place and will trigger if the level 1 price of the security reaches (or skips over) that price. A premium fee is attached to GSLOs, but this is only incurred if the GSLO is actually triggered.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.
Please note that past performance is not a reliable indicator of future results.