CFD brokers seem to be springing up left, right and centre as the popularity of the instrument continues to extend into consumer investment markets. From the large institutional traders at the top of the heap to individual, ‘bedroom’ traders, CFDs are big business, with some estimates showing as much as 50+% of all equity transaction in the UK now taking the form of the more tax-efficient, naturally leveraged CFD.
While these brokers each have their own point of difference for marketing purposes, they can be broadly broken down into two distinct types, offering similar but crucially different services for CFD traders. But what are the differences between these two classifications, and how do you settle on the right type of broker for your trading needs?
DMA – Direct Market Access Brokers
Direct market access (DMA) brokers enable 100% transparency in pricing and trading, opening up the global CFD markets to the trader. When a CFD trade is executed at a given price, the DMA broker effectively plays no role whatsoever – the trade is placed in the real-life markets directly, and must be met by a corresponding trade on the other side of the table in order to be fulfilled.
Direct market access brokers are in it just for the transaction commission – they are simply the hands-free middle-man, offering an interface between the trader and the markets at large. This means that on the one hand, the price you pay for your CFDs is absolutely and solely a reflection of market rates – there are no other factors playing into pricing. However, this also means that each transaction requires a live counterparty, which in turn affects the liquidity of the market. In layman’s terms, this can mean it’s harder to buy and settle your positions, and trading decisions can entail sometimes costly delays (especially for less well traded CFDs).
The second main type of CFD broker is the Market Maker. Market makers are involved in actually making the markets for the CFDs themselves, which they then hedge in order to counterbalance their risk. Rather than serving as merely a portal between the trader and the markets, market makers are the market as far as the trader is concerned, and it is their pricing that is used as the basis for buying and selling contracts.
This naturally means that pricing isn’t quite as good as on the real markets. That makes sense, given the extra layer of input and risk absorbed by the market-making broker. However, where market makers really shine is in delivering much more real-time liquidity. Regardless of the demand for the CFDs you’re selling, or the supply of the CFDs you’re buying, market makers execute traders often with considerably less delay than is the case in the real-life markets, because the broker is the market maker – i.e. the broker is the counterparty to the trade, rather than some other investor or fund that must be matched to your trading position.
The difference between these two different broker classifications is a technical one, but nevertheless a potentially important one for delivering the trading outcome you desire. Whether you’re looking for more accurate trading, with the ability to influence the underlying market in your relevant CFD, or you’re content with the slightly less favourable rates but increased liquidity offered by the market makers, deciding on the best CFD broker for you will require a full consideration of the pros and cons, and a thorough understanding of the unique features of each distinct broker category.
How Are CFDs Priced
CFDs are priced on the basis of the market rate plus or minus a weighted factor that the broker will include to more accurately reflect its impression of where the market is likely to go. While CFD prices roughly track underlying market prices, this added element makes them less transparent than exchange traded CFDs, or than alternative instruments which more closely follow market price. For some traders, this problem causes them to sacrifice a degree of liquidity for a move into DMA CFD trading, where positions are opened directly on market exchanges rather than through the broker who explicitly agrees to fill orders and make markets. This corrects the often marginal price discrepancies in CFDs as compared to underlying cash markets.