CFD Trading advantages and disadvantages by ForexSQ experts, Learn about CFD trading advantages or disadvantages in UK, South Africa, Australia, Europe, Asia, U.S. and all around the word.
CFD Trading Advantages
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The advantages and disadvantages of having an exchange traded CFD were similar for most financial products and meant reducing counterparty risk and increasing transparency but costs were higher, below is the CFD trading Advantages :
- Market Independence; the exchange had to make sure markets were fair, orderly, and transparent. ASX was independent of the parties with whom a customer received advice and deals through. This separation of responsibility between broker and exchange provided customers with choice as to whom they wished to execute their business, and with one standard contract specification for all ASX CFDs.
- Transparency; ASX reported on all ASX CFDs transacted, open positions, bids, offers and volumes. ASX CFDs were traded in the same way as other ASX traded contracts. ASX CFDs were offered on a separate market with a separate book to that of physical stock trading on the ASX. When trading ASX CFDs, the customer’s order was entered directly via a Participant into the ASX CFD central market order book. This order book was available for the market to see. All orders were executed on a strict price/time priority.
- Counterparty risk; all settlement obligations were cleared and guaranteed by SFE Clearing Corporation (SFECC) which had a statutory obligation to operate “fair and efficient” facilities. These were monitored by both the Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (RBA). The ASX claimed this reduced counterparty risk as the payment is guaranteed by the exchange central clearer which had much larger capital reserves than any individual broker. By comparison, all over-the-counter CFD providers in Australia are required by law to hold an Australian Financial Services Licence issued by ASIC. This license includes the requirement to hold client funds in segregated accounts so that a company failure will limit the loss for clients. However, CFD providers may still be able to access this money to cover their own margin requirements, and if this resulted in overall company loss or foreclosure, a trader’s deposit could still be at risk.
CFD Trading Disadvantages
- Higher costs; the exchange and the clearing house needed to earn money and so charge fees as well as the broker. In addition the broker’s administration costs tended to be higher to comply with exchange and clearing requirements.
- Limited products; Australian Securities Exchange only offered a small number of CFDs, did not cover all physical shares on its own exchange and did not offer CFDs on shares from any other country. It did offer a small number of global indices and some currencies. In contrast, CFD providers typically offer CFDs on thousands of underlying products from all over the world, including shares from all major markets as well as all major indices, commodities, currencies and treasuries. Unlike the ASX CFDS, the flexibility and ease of creating a new CFD on any underlying traded instrument as well as not being limited to exchange definitions has been seen as one of the strengths of CFDs.
- Pricing; one side effect of the separate order book for CFDs on the exchange was that prices and spreads were based on CFDs orders only. This meant that the price and spread of an ASX CFD could be different from that of its underlying instrument. In some instances, while the underlying instrument was liquid and heavily traded with a tight spread the ASX CFD based on that instrument may have had little or no liquidity and a wider spread. The viability of trading would depend on the ASX attracting enough participants to its CFD products to create a liquid market.
The disadvantages of the ASX exchange traded CFDs and lack of liquidity meant that most Australian traders opted for over-the-counter CFD providers.
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