Articles of Interest

Benefits of trading CFDs
CFDs are derivative products that offer distinct benefits including:

Liquidity
CFD prices are obtained directly from the underlying market. This means CFDs give you access to the liquidity in the underlying market, plus liquidity offered by the CFD provider. Most of the time there is much more liquidity in the CFD market than in the underlying or physical market due to the higher number of participants including private and institutional traders.

Trade on margin
CFDs are traded on margin, typically from 5-10% to for shares and 1% for indices. This means a more efficient use of your capital as you only need to allocate a small percentage of your funds to secure a trade. This also enables you to magnify the returns on your investment with a much smaller capital outlay.

Trade long and short
Before CFDs, going short a stock could only be done through a traditional broker that would charge hefty fees on top of the normal brokerage. With CFDs traders can now go short any position or market without any extra cost. Going short is as easy as going long with CFDs. Going short also provides another benefit that was not available before. Your CFD provider will pay you interest on a short CFD position. This is similar to earning interest on your bank account balance.

Trade on-line
With an estimated 13.4 million Australians with Internet access online share trading has also been on the increase, giving traders more control and constant access to their positions. Most CFD providers offer free software and CFD trading platforms that allow traders to place orders online even outside normal trading hours.

Low transaction cost
Trading CFDs can cost you as low as $10 each way compared to traditional stock brokerage rates of around $25-30. Although transaction costs are a small portion of your overall trading cost, they have an impact on your bottom line once the volume of your transactions increases.

Access to international markets
CFDs open up a wide range of trading instruments. Most CFD providers offer CFDs on Australian and International shares, indices, sectors, commodities, foreign exchange and treasuries. Most of these markets were not available or accessible to private traders before due to the complex nature or complicated set up of traditional brokerage accounts.

Receive benefits of dividends and stock splits
As CFDs reflect the price and movement of the underlying physical share, they also mirror any corporate actions that take place in the underlying share. This means, if you are a holder of a share CFD, you will also receive dividends and stock split benefits once they become due. However, you are not entitled to any voting rights or franking credits. On the same vein, when you are short a share CFD and the underlying stock goes ex-dividend, you have to pay the dividend amount as you would if you were short the physical share.

To find more helpful CFD trading tips you can download our free CFD Guide.

There are two main types of CFDs, these are:

1. Direct Markets Access and;
2. Market Made

Some CFD providers only offer one type of CFD others offer both. The most common type of CFD is the market made variety, typically this type of CFD is offered by CFD providers that also offer spread betting and originate in the United Kingdom where spread betting is popular.

All CFD traders or potential CFD traders should understand the differences between the mechanics of both types of CFDs and the fee structures associated with them.

Direct Market Access (DMA) CFDs
Direct Market Access (DMA) CFDs mirror the price and liquidity of the underlying instrument on which the CFD is based. DMA CFDs are the most fair and transparent type of CFD available. When trading DMA CFDs the trader is a "price maker". DMA CFD traders can enter and see an equal order flow onto the underlying exchange, this guarantees that at all times they receive true market prices on every trade. DMA CFDs offer traders real time execution, guaranteed market prices and participation in the order book and opening and closing phases of the market this provides a significant advantage for scalpers.

DMA CFD providers do not profit directly from performance of the CFD trader, as all CFD positions are 100% hedged. This means that if you buy the CFD, the provider will instantly buy the underlying equity as their hedge trade. 

Points to note
• The quoted price of DMA CFDs is the same as the price quoted on the underlying exchange;
• DMA CFD orders flow directly onto the underlying exchange;
• DMA CFD traders can be a price takers or makers and participate in the market depth on the  exchange, and;
• DMA CFD traders can participate in opening and closing market auctions.

Market Maker (MM) CFDs
A Market Made CFD does not mirror the price on the underlying market. Market Makers that offer Market Made CFDs derive their CFD prices from the underlying instrument on which the CFD is based rather than quoting the exact exchange price of the instrument like DMA CFD providers. Market Makers act as an intermediary to the CFD trade and have the ability to alter the price of the CFD, price alterations often occur in their favor, often resulting in stop orders being triggered and slippage which can add a significant cost to the trade.

Market Makers do not hedge 100% of their CFD positions, typically they hedge only the resulting amount after their clients long and short positions net each other off, however in many cases they do not hedge at all and often directly profit from their client’s losses. When trading Market Made CFDs trades do not flow directly onto the exchange, they are at the discretion of a dealer as a result orders are filled slower and at inferior prices.

Points to note
• MM CFD traders do not receive the same prices as those quoted on the exchange;
• MM CFD spreads are often widened and orders re-quoted;
• Market Makers are price takers not price makers, this means MM CFD traders cannot participate in the underlying order book;
• MM CFD traders cannot participate in the opening and closing market auctions and;
• Some Market Makers profit from the performance of their clients positions.

Market Made CFDs do have some benefits over DMA CFDs in that they are generally offered over a larger range of stocks and indices. Market Makers are also able to offer additionally liquidity in larger stocks, the reason for this is because they have positions on their internal order book which they would like to clear.  

Market Makers often re-quote clients when they attempt to buy or sell a CFDs, re-quotes occur as a result of the Market Marker adjusting their internal order book to compensate for a lack of liquidity at a particular price level on the underlying exchange.

So which type of CFD should you choose:
When comparing the two types of CFDs you should consider whether you’re trading style and the instruments that you trade suit either a Market Made or Direct Market Access model. Typically scalpers and active traders choose DMA CFDs over MM CFDs as there are no re-quotes and the trader can be a “price maker” through participating in the underlying order book of the stock which they are trading. Market Made CFDs are popular with longer term traders and those that prefer to trade indices and forex. The reason for this is than often Market Markers offer both indices and forex commission free. Often DMA CFD providers do not offer indices and forex on a DMA basis as by their very nature they are a market made product and cannot be traded on an exchange.

Before choosing a CFD provider you should analyse your trading strategy and choose the type of CFD that suits you best. If you are unsure of your trading strategy or would like save the hastle of having multiple CFDs account with multiple providers you should choose a CFD provider that is able to offer you both Market Made CFDs and DMA CFDs.

Other types of CFDs
It is also worth noting that there is a third type of CFD, these are exchange traded or ASX CFDs and are offered by the Australian Stock Exchange. ASX CFDs are not popular amongst traders or investors due to their lack of liquidity and wide spreads. ASX CFDs are only offered over a small range of securities, indices and foreign exchange pairs. ASX CFDs do have the benefit of being cleared and traded on an exchange however as there are no significant advantages of this type of CFD traders prefer either the Market Made or Direct Markets Access CFDs. 

With some CFD providers you can trade either Market Made CFDs or Direct Market Acess CFDs.

To find more helpful information on CFD trading you can download our free CFD Guide.