CFD Types
From 123CFD
A CFD can (theoretically) be created on the underlying price of any asset. However there are many assets that are too hard or costly to price and/or don’t move quickly enough to be financially viable which is why most CFD providers will provide a standard set of instruments to trade.
An overview of the most common CFDs provided by online brokers can be found below.
Contents |
[edit] Common Assets that CFDs are offered on
[edit] Equities
Equity CFDs are a CFD that is purchased to mimic the underlying price of the stock it follows.
Most CFD providers will allow you to trade on your local exchange, plus a range of other exchanges. Usually trading is provided on larger indices such as the S&P 500 but some brokers may include small cap companies in their arsenal.
The most common exchanges that brokers allow the trading of CFD stocks within include:
- NASDAQ - The National Association of Securities Dealers Automated Quotations system
- NYSE - The New York Stock Exchange
- LSE - London Stock Exchange including
- ASX - The Australian Securities Exchange
- TSE - Tokyo Stock Exchange
One of the great things about trading CFD's is that it is just as easy to short a stock as it is to go long meaning you can profit from both increases and decreases in the price of a stock.
Please see Equities for a full overview on trading Stock CFD's
[edit] Index (Indices)
Index CFDs are a CFD that is purchased to mimic the underlying price of the index it follows.
Stock indices are derived from a selected basket of equities, picked from a single, or multiple stock exchanges. Indices are created by organizations such as McGraw-Hill's Standard & Poor (S&P) indices and The Dow Jones Industrial Average run by the editors of The Wall Street Journal.
Using CFD's you can trade almost every index on the globe with incomparable ease. Traditionally if you were to do this you would be forced to buy a weighted portion in every stock listed on the index!
Some of the common indices offered by CFD brokers include:
- The Dow Jones Industrial Average
- The S&P 500 Index
- The British FTSE 100
- The Australian ASX S&P 200
- The German DAX
- The Japanese Nikkei 225
- The Hong Kong Hang Seng Index
See indices for a complete guide on trading index CFDs
[edit] Industry Sector (Sector)
The Global Industry Classification System (GICS) allows investors to classify stocks into groups according to their industry. These ‘groups’ are most commonly coined sectors. If a trader has a particular view on a sector (eg resource stocks are going to fall due to falling metal prices), they may decide to trade the sector rather than playing the guessing game on individual stocks within that sector.
Most major exchanges will provide data on theses sectors, available for viewing on their websites. The Standard and Poor’s website also offer’s a booklet on sector classification. Sectors, besides being industry specific, trade very similar to indices where various companies are placed into a basket in weighted proportions then pegged to an index. The rise and fall of the companies within the sector will cause for a rise and fall in the point value of the index. When trading CFDs the index is traded at a certain dollar value per point on low margins (usually 1-3%) within trading hours.
Sector Trading is unique to CFDs as no futures contracts allow you to trade them directly
Common Industry Sectors Include:
- Resources
- Financial
- IT
- Energy
- Utilities
For a full overview on trading sector CFDs click here.
[edit] Foreign Exchange (FOREX)
Trading foreign currencies through CFDs is almost identical to trading them through any other online FOREX platform. Trading them through your CFD broker however allows you to conduct all trades from the same place, make portfolio reporting easier and take advantage of lower margins. Most CFD providers will allow you to trade the majority of foreign currencies including:
- USD/EGB
- USD/AUD
- USD/YEN
For a full overview on FOREX CFDs click here
[edit] Commodity
Commodity CFDs, unlike most of the other forms of CFDs are actually priced from the value of the commodity trading on the futures market. Not on the physical value of the commodity it’s self. This is because in real life, the only way to trade commodities on any type of exchange is through futures, thus this is the most quoted and traded price. The reality of this is that Commodity CFDs mimic the futures value of the commodity including its trading times (futures trade for longer periods each day than shares) and individual tick value. In addition to this, commodity CFDs DO have an expiry date and need to be rolled over at expiry, identical to if you were holding the future its self.
Common forms of commodity CFDs include:
- Spot Gold
- Spot Silver
- Crude Oil
For a full overview on commodity CFDs click here
[edit] Different 'Markets' that CFDs are traded on
[edit] Synthetic Markets
Synthetic Pricing relates to how your CFD broker creates the bid/ask spread for any particular CFD. This will usually start with the broker examining the underlying asset then placing the policies or rules it has determined and pricing them into the spread (see below for Costs of the Spread).
The Spread can become costly when trading on a Synthetic Market with Synthetically priced CFDs. Synthetic Pricing relates to how your CFD broker creates the bid/ask spread for any particular CFD. This will usually start with the broker examining the underlying asset then running it through a predetermined system of policies and rules to output an inflated spread. For instance, if the underlying ask price of a stock is $20.00 (on the securities exchange) your broker may choose to sell it to you at a price of $20.05. This is a fairly simple concept to understand but it is easy to see the costs that can add up over time. If the broker makes $0.05 on every CFD you purchase, a position of 1000 shares will equate to $50. If you add commission of 0.01% on top you are looking at $60 in costs as opposed to $10. Most brokers aim to provide a tight bid/ask spread and DMA providers provide a perfect spread increasing the fairness to traders.
Be warned, this is how the 'commission free' brokers make their money. They provide a loose bid/ask spread, charging you every time you enter or exit a position (relative to the underlying market) which can equate to much higher fees than the commission charging brokers. The Spread can become costly when trading on a Synthetic Market with Synthetically priced CFDs. Synthetic Pricing relates to how your CFD broker creates the bid/ask spread for any particular CFD. This will usually start with the broker examining the underlying asset then running it through a predetermined system of policies and rules to output an inflated spread. For instance, if the underlying ask price of a stock is $20.00 (on the securities exchange) your broker may choose to sell it to you at a price of $20.05. This is a fairly simple concept to understand but it is easy to see the costs that can add up over time. If the broker makes $0.05 on every CFD you purchase, a position of 1000 shares will equate to $50. If you add commission of 0.01% on top you are looking at $60 in costs as opposed to $10. Most brokers aim to provide a tight bid/ask spread and DMA providers provide a perfect spread increasing the fairness to traders.
[edit] DMA
Direct Market Access (DMA) pricing is quickly becoming the most popular form of CFD pricing (if it isn't already). With traders seeking fairer pricing the the form of tighter bid/ask spreads and the increasing competition between CFD brokers, DMA Access has prevailed among most CFD Brokers.
When using DMA pricing, a broker promises to deliver a bid/ask spread identical to that of the underlying market. This gives many advantages including the ability to participate within a real electronic order-driven market and gain access to the grey market. The largest limiting factor of DMA trading is the liquidity provided (which also mimics that of the underlying market).
The other advantage of DMA trading is that it ensures a delta of 1. A phenomena rarely experience with other derivatives (and synthetically priced CFDs).
DMA Trading is usually more costly to the trader in terms of commission and monthly access fees, but the savings that can be made from the controlled spreads usually makes up for the additional fees.
[edit] Exchange Traded
While this blurb may be too ambitious calling Exchange Traded CFDs ‘the future’, they are not an established product as of yet and thus the hype surrounding them has not been justified. The SFE (Sydney Futures Exchange), now owned by the ASX is at the back end of a new instrument named Exchange Traded CFDs. This idea is so good that there is speculation many other exchanges around the globe are seeking to implement a similar system. The SFE is set to launch the worlds first CFD market of this kind in late September and already has most of Australia’s largest market participants lining up for a piece of the action.
Basically the goal is to create a regulated market for trading CFDs, where individual traded are monitored by an authorized government body. The ultimate purpose for this type of market is perfect transparency. The simple workings of exchange traded CFDs are that the broker or provider is required to hedge every CFD transaction by actually purchasing the shares on the market its self. This will give perfect synchronization between the CFD traders and the price movements of the underlying exchange. Essentially, Exchange Traded CFDs aim to include all the desirable components we associate with stock exchanges along with all the desirable components associated with trading CFDs.
