When deciding to trade, one of the first decisions we face is which product to trade. Depending on where you are in the world that choice could include equities, futures, CFDs and FX markets. Which choice you make can have a significant impact on your success; they cannot be viewed as equal particularly from a day trader’s perspective (which is what I am investigating here).
CFD and FX platforms are often sold as being ‘commission free’ and I know that this appeals to many retail traders. Who doesn’t want to save money? It sounds like a no-brainer. But of course it isn’t.
For one thing, investigations into the CFD industry has shown that some providers move clients away from the ‘commission free’ CFDs and onto equity-type products which incur fees. They may not be commissions but they are still fees.
Of more importance to day traders is the fact that often the spreads on these platforms are larger than for the related futures.
If the bid/offer spread on Crude Oil futures is 10cents wide while the spread on a Crude Oil CFD is 20 cents wide, you would be better off paying the broker commissions and trading futures (assuming the same trading size).
Professional traders have no problem paying commissions to access professional quality products and markets. If you want to progress to a more professional way of trading you should take this approach too.
The Real Liquidity
FX platform providers often sell FX markets as being the most liquid in the world and we are told, this is a great reason why we should trade them. There are two key points that I want to make about this.
Firstly, as a small retail trader, liquidity is typically not an issue for you. The vast majority of markets you are likely to want to trade will have enough liquidity for you. If you were trading in millions of dollars then liquidity is of concern but people with $5,000 accounts don’t need a trillion dollar market to get filled easily.
Second, the trillion dollar liquidity number that is usually touted by FX providers is for the whole FX market and does not relate to the liquidity on that particular platform. The liquidity on any given retail FX platform will be a fraction of that trillion dollar figure. Further unlike, equities and futures, the actual level of liquidity and trading volumes are often not reported.
Who are you trading against ?
One of my mantras with the Norden Method is that we don’t need to be better than everyone, we just need to be consistently better than at least one type of trader and then look to exploit their weakness. For the Norden Method, we target other retail traders because we believe that they are the weakest and they are consistently poor (and have been for decades). It makes sense to me to try and trade against the weakest.
The only product that always always allows us to trade directly against retail traders are futures.
Some equity markets do; but some have their orders routed through intermediaries or market makers.
With FX and CFD platforms your orders are filled by the provider; you are essentially trading against them.
Some CFD providers will claim that they offer direct market access (DMA) CFDs where your order goes directly into the underlying exchange. But you are still not trading directly against the traders on that exchange, your order is being routed via a third party. Clearly it would be preferable to cut out the middle man.
How you get filled
For day traders, how you get filled is important. This is actually an integral part of the Norden Method.
If a contract has a current bid/offer spread of 120.00b/120.01o ask yourself, can you get filled on a 120.00 bid (that is can you buy at 120.00) when the market is still 120.00b/120.01o? Or will you only get filled if the market goes to 120.00 offer or below?
For futures markets the answer is that yes, we can get filled on a 120.00 bid with the market still being 120.00 bid.
With FX and CFDs that are routed through the provider, it is unlikely. The same goes for equities that are routed through market makers. So on these products you are likely to only get filled when the trade is against you. Think about that; every time you get filled, your trade is losing money. This might not be much of an issue for longer term traders but the shorter your trading time frame, the more of a problem it is.
From time to time, markets can provide opportunities that are not typical. For example, thin liquidity may trigger trades at extreme prices or the bid/offer spread may widen. Again, ask yourself can I exploit these opportunities?
Typically the only way to do so would be to trade directly into the market. If you are trading on a CFD or FX platform or equities via a market maker then it is likely if not certain that the firm you are trading against will exploit this opportunity.
What information can you see?
Day traders in particular need to know everything they can about the current market. At a minimum we need to know:
- What price is the contract trading at on my platform?
- What orders are placed above and below on my platform?
- How are orders being filled on my platform?
- What volumes are going through on every trade on my platform?
This information must be live time and must be equally visible to all participants at the same time.
With futures, we see this and lots more information. With CFDs and FX we often don’t or some of this data may be delayed (even slightly).
Fair and transparent – example Stop Loss orders
It is essential that we trade in a market that is as fair as possible and is a level playing field (as much as that can be possible).
One way we can determine fairness is to investigate stop loss orders.
When you trade CFDs and FX and any product where you trade against a provider (market maker), they get to see where every trader’s stop loss orders are. Remember that these firms are market participants, they are trading against us. Information such as stop loss order placement can be of great help to a trader. But only the provider has this.
Futures markets operate differently. We do not trade against the exchanges, they merely facilitate a market. The brokers and platforms who route our orders do not trade against us. No participant knows where orders such as stop loss orders are (although if you use widely known technical analysis levels then some traders can guess where they are).
Quite simply, futures markets are fairer and more transparent.
When you trade CFDs or FX you will almost certainly have to trade on your provider’s platform. To new traders in particular, these will look quite sophisticated with charting packages and perhaps other bells and whistles. But at the end of the day, they were created by the firm you are trading against and as explained in the previous paragraphs, they don’t have lots of information that are actually important to day traders.
While these platforms are ‘free’ you should invoke the old saying that there is no free lunch. Information and tools which are free will rarely have edge.
If you want edge and better tools you will have to pay for them. That is the professional way.
This again, is where the futures industry is different. There are many trading platforms, designed for different styles of trading and most brokers offer you a range of them to use. As neither your broker nor the Exchange is trading against you, they do not mind what platform you use.
The range of information, tools and functionality of futures trading platforms is far advanced from CFD and FX platforms. When coupled with the ability to trade directly against other retail traders and exploit situations such as wider spreads, trading on a futures platform is head and shoulders above other products.
Are there benefits to CFDs or FX platforms?
If CFDs and FX platforms are so inferior to futures why do so many people trade on them?
The first and most obvious answer is that most retail traders don’t understand the issues that I have presented or how much edge they are giving away.
Secondly, many are enticed into trading by slick marketing and sales. As the platform providers trade against you, they have a desire to attract more traders onto their platforms. Additionally, as the failure rate of their clients is so high, they have a continuous need to replace the losers. So marketing is a significant aspect of CFD and FX providers’ business model and they target new traders in particular. Whereas, futures exchanges don’t trade against us so they are less conspicuous in their marketing particularly to newbies.
But historically one attraction of CFD and FX platforms was the ability of traders to set their trading size. While futures markets have a standardised tick value which was sometimes too high for retail traders, CFD and FX platforms enable traders to set trading sizes from as little as a dollar a point move.
In recent times though, futures exchanges have responded by offering smaller tick value contracts. For example Eurex now offer the original sized Dax futures (Eur25 per tick move) as well as a mini (Eur5) and micro version (Eur1).
I sincerely believe that choosing the wrong product can contribute to failure.
FX and CFD firms are great at marketing to retail traders; they know exactly what buttons to push such as ‘commission free’. If you want to move away from trading like a typical retail cannon fodder trader then you need to think differently.
For longer time frames and for other forms of trading such as hedging, there can be a place for the other products.
However, for day traders in particular we simply cannot give up the information and opportunities that are denied to us on most CFD and FX platforms. In a world where edge is small, this is unacceptable.
I am always intrigued when I hear of ‘professional’ day traders who trade on these other platforms. I personally cannot understand how a real professional day trader would give up so much information and opportunity.
To me, the difference between futures markets and CFD and FX platforms is huge.
When day trading there is only one choice, futures.