Be aware of predatory CFD companies

It seems that in the past few years there has been a spread of companies offering contracts for difference (CFD) and applying quite dodgy predatory tactics. And this is not specific to a single country, but it is happening all around the world. I know this since I lived in Serbia, UK, and currently living in Germany and I have received calls from companies that are based in all these countries, applying the same or very similar tactics. So I would like to warn people about that, as CFDs are very speculative products and you are very likely to lose all your invested money in a matter of days or months.

What is CFD?

The contract for difference (CFD) is a contract between two parties, typically described as “buyer” and “seller”, stipulating that the buyer will pay to the seller the difference between the current value of an asset and its value at contract time (if the difference is negative, then the seller pays instead to the buyer)[ref]. Basically, these products would follow the price of some other product, e.g. share, ETF, commodity, option, whatever, but you would never own part of the company, fund, commodity, or whatever is the underlying asset, just the company would pay you the difference if you sell higher then buy or you pay them otherwise (if you trade long, for short selling, it is the way around). The interesting thing is that you can trade anything with a contract for difference, without actually seeing the stock exchange, it is just a contract between you and the company offering it. This is important because these companies would claim over the phone to you that you are investing in stocks, funds, foreign exchange, while that is not true. None of the transactions is connected to the actual assets, apart from following the price on the paper.

What is making CFDs speculative?

CFDs are probably one of the most speculative products on the market. And there are a number of things that contribute to this.

The first one is that it is designed for day-trading. Day-trading is highly speculative and generally market can go both up and down in a day, there is very little science backing day-trading strategies. The good thing about markets is that they are a couple of percents more likely to go up in a year, and if you are a day-trader, that may make you a profit, but not much more than a long-term investor. How they design it for day-trading? They introduce overnight swaps, a small commission that would eat up some percentage of your investment if you keep it overnight. If you don’t close all your trades during the single trading day, you are losing that part of your money.

Leverage is a noob killer. There is no need probably to explain that they usually target with their marketing calls noob investors, beginners, who likely never traded before. If you are experienced in financial instruments and investment, you will see the scam in a few minutes of talking to their marketing guy. So once, they persuade you to open an account, they offer you to use leverage, which usually means they would multiply the money you invested, so you can invest with several times more money. Often, they offer 2, 5, 10, 25, 50, sometimes even 100 times more than you invested. Now, what sounds appealing to the unseasoned investor is that they can start with a fairly small amount, and each gain they make, will be as well multiplied 25, 50 times. However, also, every loss will multiply the same amount of times. So if you play with 50 times levarage, every dollar of loss will cost you 50 dolars. If you gain, you will likely reinvest. And all reinvesting will make you more exposed to big losses. In order to lose all your money with 50 times leverage, you need to lose 2%. This can happen anytime that market move 2% and they close all your trade because you can’t lose more than you invested.

Back to the predatory calls

Basically, there are maybe benefit for people who know what they are doing to trade with CFDs, however, one needs to know the risks. On people that do not know the risks, these companies earn a lot of money. So let me describe some of these calls:

Usually, they would present themselves as a company that would like to introduce you and help you with investing and trading. They would say some ridiculous stories of how successful they are and how this year, despite all the crises was the best for them (no matter what crises or year it is, there are always some crises to mention). They would mention some prizes they got for the best or most innovative trading platform (from questionable sources). They will tell you that they will guide you and send you reports from their analysts who have 20+ years of experience in trading and that if you would like you can follow the advice they give you. Once I went with agreeing to them to send me some information, and basically what they sent me was quite useless. They sent me that the price of gold is record high and that if I invested 2 weeks ago, I would be gaining some 10%. And I was like, how this helps me, if you sent me this two weeks ago, it would be beneficial, but now it is going to oscillate around that price for a while and maybe fall a bit mid-term, and since you are charging for overnight swaps, mid and long-term is not an option. Also, I got advice to invest in Lufthansa because “the government is investing in them in 2020 around 9 billion euros”. Of course, they were talking about the German government bailout of Lufthansa, because otherwise, it would bankrupt, and we probably all know it is not the greatest idea to invest in the company at severe risk of bankruptcy.

Usually, they first send some junior marketer to talk to you. Now I have been trading for a while now, about 4–5 years using various accounts and products. During my Ph.D., I was head of technology in Manchester Trading and Investment Society at the University of Manchester. I have been involved in several smaller fintech initiatives, and I like to follow some financial and political news. These people don’t know much, sometimes they don’t even have any formal education like University. So they don’t go far on me, so they usually tend to transfer me to someone more senior who knows a thing or two. Now, these people are often quite good at explaining some benefits of investment, but they would obfuscate things that are not beneficial, like overnight swaps, risks of trading on leverage, etc. And they are very persistent in trying to get you to sign up and use their platform. However, my advice would still be not to go with them!

Let's look at the performance of trading

Let me start by saying that markets (so stocks) on average yearly gain about 5–7%. So, if you buy some ETF that is composed of S&P500 or FTSE100 or some similar fund, that is very likely to be your gain yearly.

How average trader trades with CFDs?

• Almost 280,000 customers traded CFD products each month in 2017.
• There are 100 different FCA-authorised specialist CFD providers.
• FCA analysis revealed that 82% of CFD customers lose money.
• The average loss when trading these products is £2,200.

This does not seem like a good deal to anyone reasonable. If you wondered FCA stands for Financial Conduct Authority and is a financial regulatory body in the UK.

Also, based on the new regulations in the EU, most of the portals offering CFD trading need to present a popup saying how many of their customers lose money. I will present a few from several companies:

As you can see, most present that over 70% of their users are losing money on CFDs. Now in relationship to leverage, you can check this chart:

Even if you look at the brokers with lowest percentage of losing accounts:

The image is not bright. Obviously, if people are leaving and closing accounts because they lost money, in order to keep making money, they need more clients. So they resort to hiring army of people trying to make phone calls and try to fish for new clients who would give them their money in form of negative differences in the contracts. The whole business model is set on getting clients and robbing them of their money, by presenting quite low spreads but betting on them getting high leverage and exposing themselves to market swing big enough for them to get all your money. So in conclusion, don’t go for CFDs, especially if you are unseasoned in investing. Get a few books, and learn how to invest in some less risky assets, like ETFs, stocks, and alike.