Best CFD Brokers

An acronym for 'Contract for Difference', CFDs are financial instruments that allow you to speculate on the price difference of an underlying asset.

Being a derivative instrument, CFD trading does not involve the physical exchange of the financial instrument. Rather, it is a transaction in which two parties exchange money about the movement in the underlying asset's value from the opening to the closing of the trade.

CFDs allow you to invest in both bullish and bearish markets.

In the case of a bullish market, you open a long position to gain on the rise in the underlying asset's price.

In the case of a bearish market, you open a short position to profit on the downward trend in the underlying asset's price.

CFDs are traded in 'Over the Counter' (OTC) markets.

OTC markets denote those markets where the financial contracts are concluded and the related trading occurs outside the official stock markets.

One feature of CFDs is that they allow you to invest using leverage. We can define leverage as a kind of 'capital multiplier', i.e. an instrument that allows for more exposure than the capital invested..

Let's take an example: You have a capital of 100€ and you want to invest, via CFDs, in shares with leverage of 1:10. Thanks to the leverage effect, with an amount of 100€ you will have an exposure on shares for a total value of 1,000€ (since 100€ x 10 = 1,000€).

Related to leverage is another very important concept: margin.

Margin represents the capital required to open a position and is equal to the nominal capital divided by the leverage.

For example, if you want to invest in 5,000€ of shares with 1:20 leverage, the margin required will be 250€ (5,000€ / 20).
The required margin is composed of the initial margin, i.e. that part of the margin on which profits and losses will be generated, and the maintenance margin, i.e. the part of the margin needed to keep the position open.

Usually, initial and maintenance margin have a specific weight of 50% each. The maintenance margin is very important because, based on it, you can trigger the margin call, which is a warning that the broker sends you when the maintenance margin, due to a losing position, gets too close to equity (given by the sum of the available balance in your account, the initial margin and the maintenance margin)..

Taking the previous example, i.e. 5,000€ of shares with 1:20 leverage, the scenario would be as follows:

• Available balance: 50€

• Initial margin: 125€

• Maintenance margin: 125€

• Equity: 300€

If the equity, now 300€, were to fall below the maintenance margin due to a bearish trend in the price of the shares purchased, a margin call would be triggered.

In this case, you could decide

1. to keep the position open (which will still be closed by the broker should the price continue to fall)
2. close the position yourself,
3. add more equity to increase the equity.

Warning: as leverage increases the financial exposure of the investment, it can multiply gains, but also losses.
For this reason, EU capital market regulation provides for a leverage for retail investors (the type of investor that enjoys the most protection from the legislator) of a maximum of 30x.

Having explained what CFDs are and how they allow leveraged investing, let us now look at the pros and cons of these particular financial instruments.

What are the advantages of CFDs? To help you assess why you should invest with CFDs, we propose a comparison between CFDs and futures, other derivative instruments which allow leveraged investing.

Similar to CFDs, futures are financial contracts which allow two counterparties to exchange an underlying asset but at a pre-determined future price.

CFDs are the best choice for retail investors with moderate levels of capital and limited financial knowledge and experience.

In addition, compared to futures that are traded on regulated markets, CFDs very often do not have trading commissions charged on each opening and closing of a position, but only the spread to be paid to the broker you have turned to for CFD trading.