No Commission CFD Brokers

There are two types of CFD brokers -

1. CFD brokers that quote their clients the same dealing price as if the deal was being done on the London Stock Exchange. These brokers charge a commission, usually between 0.1% - 0.25% depending on how often one trades as well as the size of the deals
   
   
2. CFD brokers that charge zero commission but quote their clients their own prices. These prices for larger FTSE 100 stocks are often close to official cash price but for mid level or small cap stocks can be markedly different
   

So which style of CFD broker is better?

Remember the old and time tested saying from the City of London - ‘there’s no such thing as a free lunch’.

The brokers that offer zero commissions are not doing it from the kindness of their hearts. They will therefore look to claw back their losses at every opportunity. Perhaps the best way to look at the problem is to note there are few professional traders (those who trade for a living) that use the commission free CFD brokers. All them much prefer to deal on London Stock Exchange Official prices and pay the commission.

If you also look at who the zero commission CFD brokers attract as their clients you’ll see that their services are very much targeted to the retail client.

In my personal trading I have done 1,000s of CFD deals over the years and have never considered using a commission free broker.

CFDs & Margin

• CFDs are leveraged products which mean they use margin (borrowed money)
  
  
• One of their major advantages is that only a percentage of the overall value of the stock is needed to control the full amount. Buy £10,00 worth of Tesco using a CFD and you’ll only need to deposit around £1,000 to control the full £10,000
  
  
• It is important to note there are 2 types of margin - Deposit & Variation

Deposit Margin

• Deposit Margin is simple. Note, it is sometimes called initial margin
  
  
• For most CFD trades, both long and short positions the initial margin requirement is between 10%-20%
  
  
• So if you buy 10,000 shares of ABC stock at £1.00 using CFDs you'll have to deposit a cash sum of between £1,000 and £2,000
  
  
• As a general rule of thumb, the large the stock the smaller the initial margin. So a Tesco would be around 10% (sometimes even as low as 5%) but it might be 20% or higher for a company with a market capitalisation of just £100million
  
  
• Deposit margin is paid when a trade is opened and returned in full when the trade is closed

Variation Margin

All margined products use some sort of variation margin where profits and losses are 'marked to market' at the close of business everyday

• If you bought a stock using CFDs at £1.00 and it closed that day at £1.05 you would be credited with 5p of profit (x the number of shares) at the close of business. The 5p profit is variation margin, or positive variation margin
  
  
• If the following day the shares closed down 5p at £1.00 you would have lost 5p. Remember, although you bought the shares at £1.00 you were paid 5p profit yesterday when they rose by that amount. So although you bought the shares at £1.00 the variation margin is set via the closing price of one day to the next. In this example at the close of business you'll have to pay 5p in negative variation margin
  
  
• Think of variation margin as the daily profit or loss which is credited or debited from your account also on a daily basis
  
  
• Some further information on variation margin is listed in the Spread Betting section

CFDs & Financing

• If you were to buy £10,000 of HSBC shares using CFDs then your broker would ask for a deposit of £1,000 (assuming a 10% deposit margin) and would lend you the balance of £9,000
  
  
• He will then charge you interest on the loan until the position is closed
  
  
• If the trade was a day-trade and the position was not held overnight there would be no interest to pay
  
  
• The interest charged is usually around 1%-2% over LIBOR (London Interbank Offered Rate) which is the official short term interest rate and mimics the base rate level pretty well
  
  
• Note, that this interest is charged on a daily basis, 365 days of the year so it includes weekends
  

However, on a short CFD position because you are lending stock to the market you will be paid interest, usually around 2% minus LIBOR, (depends from broker to broker). And of course if the short position is a day trade then no interest is receivable.

Don't let the interest payment put you off CFDs because it's cheap. Studies have shown that it costs around £1.64 per day per £10,000 of stock (interest rate used is 6%).

Important point – As a general rule of thumb if you hold a CFD trade for more than 30 days the interest payments start to get expensive. This is why CFDs are designed for traders, and not buy and hold investors.

CFDs & Dividends

• Holders of long CFDs in a stock that pays a dividend are entitled to receive this
  
• However, different CFD brokers have different policies, some only pay out 90% of the value of the net dividend. This is an important point to check when considering a broker
  
  
• Conversely, the holder of a short CFD is required to pay a sum equal to the gross dividend
  
  
• The deciding date for the entitlement to a dividend (or payment) is the same as the ex-dividend date declared by the underlying company
  

This means that if you have bought a share via a CFD and the share pays a dividend you'll receive the dividend payment via a cash credit to your account.

One point that many traders don't realise when shorting stock via a CFD is that while you will have to pay the dividend (the equivalent cash amount will be debited from your account), the stock price will usually fall by the same amount on the ex-dividend date.

In effect you may have to pay 5p per share but then the share will also fall 5p. The short seller therefore gains no advantage nor disadvantage when dividends are paid out.

LearnMoney Comment:

The cost of financing as well as how Dividend payments are credited/debited is a critical but often under-investigated fact when deciding which CFD broker to open an account with. Potential CFD users are therefore urged to not only fully understand these points but to check out all the charges relating to dealing in CFDs.

For example it is possible for a broker to offer a client 'cheap' commissions but then charge a far higher rate of interest on the financing. However, you’ll often find that a broker charging higher commissions but cheaper financing costs is the better one to deal with.