Contracts For Difference Market
While there is a formal Contracts for Difference market in Australia created by the Australian Stock Exchange, the vast majority of CFD contracts are not traded on an exchange. In 2008 the ASX CFD market accounted for just 1% of the total volume of CFDs traded.
CFDs Are Over The Counter Derivatives
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 CFD broker and to close out the contract a transaction must be made with the same CFD broker. Contracts opened with one broker cannot be closed through another broker or CFD provider.
The prices that are quoted are normally the same as the underlying market that you are trading on. CFDs are priced just as they would be if you were trading the underlying market.
Hedging Your Contract
Even without a CFD market CFD positions can be reflected in the underlying market. CFD brokers will often hedge a CFD by entering a position in the underlying market that is the same as the position that is being traded.
If a trader was to buy 300 shares of BHP, the CFD 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 CFD position equals the gain or loss made by the CFD broker. The broker is said to be fully hedged.
With the Direct Market Access style of execution the CFD 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.
CFDs Offer No Guarantees
Because a contract opened with one CFD provider must be closed with the same CFD 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.
If a broker is publicly listed you can easily investigate their financial position from their reports, but for unlisted companies this information is much harder to find.
CFD 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 CFD provider normally mirrors the underlying market and orders placed with them may be executed directly in the underlying market.
