Contracts For Difference Market

Interestingly, most CFDs do not trade on a Contracts for Difference market. The Australian Stock Exchange has created a market for CFDs but as at the end of 2008 the volume traded on the ASX CFD market represented only 1% of the total CFDs traded.

Traded Over The Counter

Most CFDs are traded as Over The Counter (OTC) Derivatives and are not traded on a Contracts for Difference Market. This means that a contract is opened directly with a broker and to close out the contract a transaction must be made with the same broker. Contracts opened with one broker cannot be closed through another broker or provider. Prices quoted by the broker normally mirror the underlying market, so a CFD will usually trade at the same prices as in the underlying market.

Hedges In The Underlying Market

While no formal Contracts for Difference market exists, other than the ASX CFD market, the broker may, or may not trade the underlying instrument on the underlying market to protect the position they have taken with the individual trader. This is known as hedging a position. If a trader was to buy 300 shares of BHP, the broker could simultaneously buy 300 shares of BHP on the ASX market. By doing this any gain or loss made by the trader on the position equals the gain or loss made by the broker. The broker is said to be fully hedged. With the Direct Market Access style of execution the broker is always fully hedged. Market makers can choose how and when they hedge and may hedge their overall position rather than each individual trade.

No Guarantees With CFDs

Because a contract opened with one provider must be closed with the same provider an important point for traders to consider when opening a Contract for Difference account is to consider the strength of the CFD broker. It is no good if you have made a lot of money on a CFD position and you can not close it out when you choose to. Most brokers are large companies that are publicly traded so information on their financial strength is readily available. However not all companies are public and finding out their financial strength may be more difficult.

Contracts for Difference Market

While there is no formal Contracts for Difference market other than the ASX market for a trader it makes very little difference to the way CFDs trade. The provider normally mirrors the underlying market and orders placed with them may be executed directly in the underlying market.

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