One of the first decisions a potential CFD trader will make is choosing a CFD provider. However, how do you know whether the company you have chosen is safe and secure?
Following are some things to consider when choosing a CFD provider:
Regulation
It is essential that a CFD provider is regulated by the local financial regulator, or ASIC in Australia. Additionally, it can be valuable to research the training required of their staff.
Financial stability
CFD providers must have adequate capital and cash flow to run their businesses. This information is easier to access for larger, publicly-listed companies. As these companies need to report their performance and financial strength to stockholders, traders may be able to access historical data as well as current information.
Policy on the use of client money
A good CFD provider is required by law to keep all client money in a separate, regulated account at a top-tier Australian bank. However, this regulation only concerns client deposits, and Australian CFD providers are under no obligation to keep client net unrealised profits in a separate account.
To ensure the safety of both your deposit and your unrealised profit, ask your CFD provider about its policies on client money protection, including whether it keeps both in a separate account to its own money.
Hedging
When you open a CFD trade, your CFD provider holds the opposite position. So if you buy a CFD, as your CFD provider sold it to you, the provider holds a short position. This means that if you make a profit, the CFD provider would make a loss.
To manage this risk, some CFD providers hedge client positions. If you bought a CFD, they would open a long position in the underlying market. That way, when the provider’s short position lost money, their long position would gain, and vice versa.
A CFD provider that hedges client positions is insured against adverse market movements.
However, it is important to note that providers are permitted to use client money for hedging purposes. In a worst-case-scenario, this could result in a CFD provider losing your money on a losing trade. Consequently, is best to find a CFD provider that not only keeps your funds in a segregated account, but can also guarantee that it will only use its own funds for hedging in the underlying market.
CFD prices
Most CFD providers are either Direct Market Access (DMA) or Market Maker providers. DMA providers’ prices reflect the price of the underlying asset in the market, while Market Makers may pad the market price by increasing the trading spread.
DMA providers are more transparent, but the range of CFDs is often more limited.
Before choosing a CFD provider, it is important to understand how their pricing structure works, and how prices may vary across markets.
Re-quoting
Some CFD providers may reserve the right to re-quote an asset price after you have already placed your order, meaning that you cannot trade at the price you originally wanted. This can negatively impact the price of your trades.
It is a good idea to check whether your CFD provider reserves the right to re-quote, and the reasons behind this. Ideally you should look for a CFD provider or trading platform that is able to quote prices at better levels than where you originally intended to trade, saving you money rather than costing you money.
Conclusion
If you research all of these areas when choosing a CFD provider then you are likely to find that there can be discrepancies between different providers’ levels of security. However, doing this homework is the first step in finding the safest CFD provider possible and, as a result, managing your trading risk.