The World Of CFD Markets And Different Kinds Of Models Available – Guest Post
Contracts for difference trading, otherwise known as CFD trading, are financial derivatives which rely on speculative decisions about which way the market will go and is similar to standard share trading. The “contract” is between two parties, referred to as the “buyer” and “seller”, and stipulates that the buyer will pay the seller, the difference between the current value of an asset and its value at contract time. (Wikipedia, Contract for difference, 2012).
Trading in Contracts For Difference (CFD), has risen in popularity over recent years as it makes use of rising and falling markets, and leverage to enhance gains. There consists of three main market models in the world of CFD trading. The first is the traditional Over-The-Counter (OTC) derivative, which is usually traded with a broker or market maker. The second is the Direct Access (DMA) model, and the third is a more recent introduction, that of exchange-traded CFDs.
The CFD provider will always set out the contract terms, margin rates and which underlying instruments it is willing to trade. In order to start trading and open a position, an initial margin is required and defined by the broker or the market maker. This usually ranges from anything from 0.5% to 30% of the initial investment, depending on liquidity. Variation margin is applied, when the instrument is marked to market, and if the position becomes unfavorable. Variation margin is applied in order to prevent the positions from closing.
The price of the underlying instrument traded depends on which model is chosen:
– A Broker/Market maker is usually the preferred choice, and the contract exists between the trader and the CFD provider. The provider will set the price of the CFD on the underlying instrument, and takes all orders onto their own book. They will then hedge their clients’ positions according to their own risk model. Utilizing this model means that the price of the CFD differs from the underlying physical market. This is because the provider has a range of options available – from hedging other positions, creating hybrids, and hedging using alternative instruments to allow trading when markets are closed
– Direct Market Access, as the name suggests, allows CFD traders to view and interact with the live order books of global exchanges. DMA was created in response to concerns that the price in the market maker model doesn’t always align with the underlying instrument and match the same price. The provider assures the trader it will perform a physical trade on the underlying market to match each CFD. The trader does not have ownership of the underlying instrument as in the Exchange model
– CFD trading through an Exchange means reducing counterparty risk, increasing transparency and market independence, but as a result drives costs higher. The downside, however, to this model is that orders are placed on a separate book. In addition CFD trading through a centralized exchange is very much dependent on attracting enough participants to its CFD products in order to create a liquid market.
Disclaimer – FX and CFDs are leveraged products that can result in losses exceeding your deposit. They are not suitable for everyone so please ensure you fully understand the risks involved. The information in this article is not directed at residents of the United States of America or any other jurisdiction where trading in CFDs and/or FX is restricted or prohibited by local laws or regulations.
This post was written by Nick Taylor on behalf of LMAX Exchange – a retail contracts for difference (CFD) and FX trading venue. Nick regularly contributes to various financial news blogs and main interests including stocks, shares and CFD trading.

This post has 6 comments
March 25th, 2012
For sure when there is big leverage, there is an opportunity to make a lot of money in short time, however this holds the highest risk. I think CFD is coming more and more popular every single day. However
Carl recently posted…Is Your Firm Ready for Premium Pricing with Micro-Niche Marketing Strategies and Tactics?
April 19th, 2012
Absolutely Carl, it’s important to understand the risks associated. We would highly recommend registering with a service that offers a demo account and making sure you’re comfortable with trading in CFDs before committing any investment.
June 15th, 2012
But with a big leverage it gives you the option to make other funds available for other trades, effectively hedging your bets across a number of different assets.
June 20th, 2012
I have been hearing so much about CFDs and I agree they are becoming increasingly popular amongst us smaller investors. The leverage factor however can be quite daunting and having played around on a few different platforms, I think the use of stop losses is a must.
I picked up some literature from Accendo Markets on the use and types of stops losses that are available to us shorter term viewed traders.
I still find the leverage daunting but the use of stop losses do put my mind so what at ease.
June 28th, 2012
I am pretty new to CFD’s but find them very easy to understand and am having a lot of success with them. There are risks involved but as long as you do your research and use a service that offer demo accounts then at least that gives you the best possible chance of understanding it all properly.
Beth Wall recently posted…Italian bond auction – successful, but pays for it
November 2nd, 2012
I have no problem with traders venturing into highly leveraged/risky asset categories, such as CFDs. My personal issue with them is they seem to be getting pitched to average investors (who have no business trading them) as a get rich quick scheme.