CFD Providers

Trading CFDs is usually done over the counter by a CFD provider, who is a market maker or a broker. The contract terms are defined by the CFD provider along with the margin rates, as well as the underlying instruments the provider wants to trade. There are two models of trading CFDs and each model can influence the price of the traded instrument.

Market maker shortened to MM is most commonly used. Through this method, the CFD provider establishes the price of the CFD and all the orders are taken onto its book. Many providers of CFD products, based on the risk model they use, hedge these positions. This could be done through selling or buying the underlying. Another way to do that is to consolidate the client positions and offset two different positions of two different clients: one long and one short or through portfolio hedges. The CFD trade is not affected because of the contract being signed between CFD provider and trader, so the  market risk of the CFD provider doesn’t count. What it can really have an important impact is price being different to physical market underlying due to the possibility that CFD providers have to consider other positions of the clients they are holding. This way, the CFD provider benefits of a lot of flexibility in what trading ties and product is concerned. They can create hedge and hybrids quite easily with the use of some alternative instruments to make it possible trading before or after the market’s normal hours, for instance. In the real market, the underlying instrument is usually matched by market maker price. Otherwise, the CFD provider would become exposed to arbitrageurs. Some CFD providers take caution and add a written guarantee to the agreement so that the CFD prices would all match the prices given by the underlying instrument.

In time there were many concerns regarding the not matching between the underlying instrument and the market maker model in terms of price. Thus, it was created the Direct Market Access, shortened to DMA. What the provider of Direct Market Access CFD guarantees is that the physical trades he does on one-for-one basis on underlying market match each trade of CFDs. There is still a contract between the CFD provider and the traders, but the extra guarantee makes sure that the underlying price and the CFD price remain the same and won’t be re-quoted. The order book of the underlying physical market will also show these orders. DMA can only be used in those markets in which the quantities of CFD and the underlying instrument are readily sold or bought  in matching quantities. The Direct Market Access is mostly used for trading CFD shares.  Because CFD providers have to cover the fees for the exchange transactions and might not manage to net together client orders in order to get scale economies, the DMA CFDs may turn more expensive. Direct Market Access model resembles more the traditional broker model and is used by institutional and professional traders because it doesn’t imply any conflicts of interest between traders and CFD providers.

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