The real cost of free CFD brokerage

As it seems that there is an ever-growing number of CFD providers offering accounts to retail /novice traders, I was wondering if people really knew what they where up against when they sign up for one of these. I think there is a total lack of recognition by CFD traders of who is on the other side of their trades. It’s not the ‘market’ but the CFD provider in the Market Maker (MM) case. Why are they on the other side? Because over time, 90% of traders lose money. People have filled hundreds of books about why traders lose, but one tactic that the MMers use is having you buy at the offer and sell at the bid if you are trading intraday. Looking at 10 to 20 point ranges this is going to greatly affect your long term expectancy.

Let me run some examples for you:

Intraday trading system. Lets assume you trade 4 times per day looking for 10 points per trade and you get them all right (yeah, I know, I wish) The SFE orders are ‘Limit’ and filled
SPI200 SFE futures contract $25 per point	CFD equivalent with two point bid/ask spread
Brokerage $5 per trade $10 per round trip	Brokerage $0
10 points x $25 x 4 trades = $1000 less Brokerage of $40         = $960.00 profit	8 points x $25 x 4 trades Less no brokerage your profit is $800.00
Difference is $160 in profit or 20 % more profit for todays effort

Why is the profit only 8 points? Because you have to buy/sell ‘@ market’ for your ‘free’ CFD you lose 2 points for the same move. It has to go up 2 points before you even get to break even. By that time the SPI trade is $50 in the money. You could say but maybe your Limit order doesn’t get hit, and that’s true. It could be even worse as you may need an extra 1 point move higher in the bid than someone who trades limit orders as they can get hit by people buying @ market. Which would mean if you sold when the SPI200 trader gets hit you could lose another $25 per trade or $100 from this example!!

What about a loss?

Intraday trading system. Lets assume you trade 4 times per day with a stop loss of 10 points per trade and you get them all wrong (it happens). The SFE orders are ‘Limit orders’ to enter and market to sell.
SPI200 SFE futures contract $25 per point	CFD equivalent with two point bid/ask spread
Brokerage $5 per trade $10 per round trip	Brokerage $0
10 points x $25 x 4 trades plus Brokerage Is $1040.00 loss	12 points x $25 x 4 trades Less no brokerage your Loss is $1200
Difference is $160 less lost or 20 % smaller loss for todays effort

Why is the loss 12 points in the CFD example? Remember you are already down two points as soon as you enter without any change in the SPI. If the SPI drops 10 points you are down 10 plus your 2 point handicap.

If you are still not convinced, what about this? Let’s assume you have a win/loss ratio of 60% with the above figures.

This is a 1 month estimated results

Spi

80 trades (4 per day, 20 days)

60% winners 48 x $46080

40% Losers 32 x 33280

Total gain $12800 not a bad month.

CFD (4 per day, 20 days)

80 trades

60% winners 48 x $38400

40% Losers 32 x 38400

Total gain $0 a total waste of a month!!!!

I know that these are not real world trades, and you can argue about the limit order fills on the entry, but one thing for sure is you will not get that 8 points on the CFD if the bid on the SPI has not moved up 10 points and taken out all Limit sell orders.

You can also say yeah, but I aim for 20-point moves or 30 points. Great, but we are talking about average trades. I haven’t seen a trader whose average trade is greater than their target. And over time, trade after trade, after trade it’s the averages that count. Remember -

Expectancy = (Probability of Win * Average Win) - (Probability of Loss * Average Loss)

Remember who is on the other side of your trade?

Someone that knows the above formula.

Someone who is happy to give you a “Brokerage Free” trade. They are not philanthropic organizations trying to give newbie’s a leg up at their own expense. They are in the business of making money.

Comments

[Phil]

Thanks for the post, good insight. I am currently using IG for index trading and Broker one for CFDs (they won;t offer the indices) Can you give an idea of reputable brokers who offer the futures.

Thanks. (gaining a lot from your blog, please keep it up!)

[Colin]

Bottom line: They're taxing you too much to make a profit.

I never really understood CFD's, anyway. Seems like turning the brokerage into a casino.

[Trembpling Hand Trader]

Phil
I use http://www.interactivebrokers.com/en/main.php
Because I can link a couple of accounts to one action. Like hit the buy button once for any number of accounts. Think Broker one has futures. I'm guessing hear but I think www.manfinancial.com.au/ is the most popular.

[sam]

Thank you for the info about the cost of the CFDs.
I am really confused now, well because I am about to take my first steps in trading CFDs and I was looking around for a CFD broker(even went to the investment expo at the weekend)and some free courses to educate my self but I am not sure now what to trade CFDs OR FUTURES.

Thank you

PS talk you again, keep up the good work

Sam

[gavin]

I'm sorry I'm not familiar with futures but dont they also have a spread in the bid/ask? Off course not as large as 2 points but less than this would you know?
And I think your example doesnt account for the possibility the system you have might have much bigger size wins than the losses. Your example assumes the average trade win and loss is a fixed 10 pts. But what if for a trend following system you can trail the profits when it moves in your favour so the reward can be a huge multiple of your risk. Also to limit your losses to a small minimum value then lets say the system averages a 1R losses to 3R profits. If you can have that type of system do you think CFDs are still viable option?

Also I noticed you using Ninja Trader? Can you elaborate what timeframe you best find is suitable for the SPI? Do you use volume or range bar chart. I find alot of traders over at the Elite Trader forums who trade e-minis prefer constant volume charts or tick charts. I too am forcing myself to relearn the basics in nothing but pure price action so am keen to share your ideas on intraday trading strategies.

[HolyGrill]

Out of curiosity: what will these CFD MMers hedge their positions with on the $5 mini futures?

holyGrill