23 November 2022
Is CFD trading a better option in 2022/23?
It wasn’t so long ago that only the elite and wealthy had access to the global markets. Back then, a traditional trading account would require a deposit of at least $25,000 (USD), and that was one of the smaller brokers.
Some investment firms required no less than $100,000 of equity just to join. But is it better to own the actual asset? Are there advantages that come with a contract for difference (CFD)? And when it comes to crypto, which venue is safer, an exchange or a CFD broker?
Let’s explore CFD trading, and compare with traditional brokers and exchanges so you can decide for yourself which offers the most security and advantages.
Exchanges: Here today, gone tomorrow
It’s all over the news, another big-name crypto exchange fails, leaving a wash of traders out of pocket. It wasn’t the first, it won’t be the last. According to a study by Tyler Moore and Nicolas Christin, the failure rate of Bitcoin exchanges is 45%. Over the last two years, dozens of crypto exchanges have died and now rest in pieces in a crypto crypt, but the one on everyone’s lips today is FTX.
The collapse of one of the biggest cryptocurrency exchanges in the world is still making huge ripples in the cryptocurrency sector. The scandal surely caused Bitcoin to lose almost 25% in a single day. FTX clients abandoned the exchange after rising concerns that the exchange lacked the funds to cover all the holdings.
FTX tried to sell itself to competing cryptocurrency exchange, Binance. Binance canceled the deal after performing due diligence on FTX's balance sheet. Nobody knows what Binance found that broke the deal, but according to its bankruptcy filing, FTX cited over 130 associated companies, valued between $10 billion and $50 billion. So what went wrong?
FTX announced that someone had gained illegal access to its accounts. Now, it's possible that it's pure coincidence that their servers got hacked right after bankruptcy. But it wasn’t long before a theory emerged that an FTX staff member simply embezzled the money. Analytics company Elliptic estimated that over $477 million in crypto went missing from the huge exchange.
So can this sort of thing happen to a big CFD broker? The straight and easy answer is no.
CFD broker client holdings
There are multiple safeguards in place to stop such a thing happening to a CFD broker’s trading clients. Let’s use Exness as a benchmark, but not all brokers offer the same conditions and protections that Exness does.
When a trader deposits with a CFD broker, their money goes to a segregated bank account. The broker can not access this money without the trader’s permission, which is given through a personal area or platform.
The broker matches or displays available funds on the trading platform and gives the trader access to the market. The broker can not use the client’s funds. This is a stipulation of many regulatory licenses, and Exness has seven. No matter what happens to the broker, the clients' trading funds are safe in a bank.
When it comes to hacking a CFD broker, the fraudster would need to hack the bank where the broker holds the client’s funds. Even if the hacker somehow managed to get access to a client’s account, withdrawals are only possible to the original bank account that funded the trading account. Any attempt to move money to a different account flags a warning in the system, and an investigation begins.
So, the client’s funds are protected against company bankruptcy and hacking. Clearly, there are more risks involved when trading on an exchange.
CFDs vs buying the asset
When buying the actual asset, leverage is not an option. If you wanted to buy 10 AAPL stocks at $148 (USD) per share, you’d need to shell out $1480. If the market moves and AAPL rises $2, you earn $20. However, for CFD trading, leverage is always available so less capital is required to open such a position.
Traditional investors often criticize leverage. Many believe it causes greater losses for the traders, and not greater profits. To be clear, 100X (1:100) leverage can increase profits by 100, but it doesn’t increase losses by 100. It does, however, increase the sensitivity of the open order by 100. Even the smallest price move in the wrong direction can stop out an account.
So the reward is higher, but so is the risk. Exness allows clients to open multiple sub-accounts, each with customized leverage ranging from 1:2 to 1:2000.
Long and short trading with CFDs
Traders have more control over how they open positions. With exchanges and traditional brokers, client profit only occurs when the asset rises. If the value of the asset falls, so does the investors' equity.
CFD traders can have exactly the same experience when “buying”, a CFD, and since the contract prices are derived from the market price of an asset, the results are almost identical. CFD brokers, especially market makers, can offer lower spreads, so for some financial instruments, you’ll get better trading conditions with CFDs.
In addition, CFD traders have the opportunity to short a currency, stock, or commodity with ease, which means there’s always a profitable scenario, no matter what the market or economy is doing.
No overnight fees
Although this is not common to all brokers, currency CFD traders can take long and/or short positions without paying the overnight fees. Another example of how a CFD broker can improve trading conditions for its traders.
The overnight fee or swap fee is an interest charged for maintaining a trading position beyond the end of the trading day. Exness is a market maker offering CFDs, so it has the ability to absorb the market price changes between trading sessions, and remove that unknown variable for traders. With traditional brokers, you pay a swap fee every time you leave a trade open overnight.
If you want to buy gold with a traditional broker, things get even more complicated, and even more expensive. There are dealing commissions whenever you buy or sell. 0.05%-0.5% depending on the amount of trading volume throughout the year. There are some discounts, but they usually only count if you’ve invested over $75K.
Then there are storage and insurance fees for the duration of your investment. 0.12% per year for gold.
With CFDs, you can hold precious metals without any of those costs, and without a time limit. And you can short or hedge positions whenever needed, trading on margin, without additional margin requirements or the need for another deposit.
The bottom line
Trading CFDs offers the same buy and sell prices, or with some instruments, better-than-market prices. It allows traders to choose leverage on multiple trading accounts to balance volatility with reward.
The CFD broker doesn’t hold the money as its own, and the withdrawal process, which is set up to combat anti-money-laundering, protects the clients from having their money siphoned off to another account. CFDs allow traders the option to buy/long or short an asset, so a healthy growing economy is not the only time a CFD trader can see profit. All in all, CFDs offer a lot for traders.