There are two types of CFD models, Market Maker and Direct Market Access. Each type has its own advantages and drawbacks and each CFD provider makes money in a very different way. It is important to become familiar with how CFD providers generate income whenever you trade. In this informative article we will look at Direct Market Access or DMA CFD providers only.
Direct Market Access CFDs are the most transparent variety of CFD available, the reason for this is simply because DMA CFD providers hedge each trade they receive from their clients in the underlying market. When buying and selling DMA CFDs you will actually see the CFD providers hedge order in the order book of the stock listed on the underlying exchange on which the CFD is quoted.
In order to hedge in a cost effective manner and enable the DMA CFD provider to offer CFDs on overseas exchanges the DMA CFD provider will utilize the execution services of a global investment bank who has exchange memberships globally. Creating a relationship with one execution provider also allows the DMA CFD provider to achieve economies of scale resulting in lower execution and financing costs for the provider and eventually the end client.
The global investment banking institutions offering the DMA execution into the underlying exchange on behalf of the CFD provider also provide the financing on the positions, this execution and financing service combined works much like a CFD but on a much bigger scale. The CFD provider’s hedge transactions with the investment bank are referred to as SWAP transactions and the service offered by the bank is known as prime broking.
A DMA CFD provider model is simple, aggregate as many client trades and positions as possible in an effort to attain reduced execution and financing rates on the SWAP contracts offered by their prime broker.
CFD providers make money very similar to any business where the business owner buys through the wholesaler and then offers the merchandise in stores to retail customers.
The formula is simple, if your CFD provider is charged 0.01% commission on their SWAP trade and pay a financing rate of 0.50% over or below the RBA rate any they charge you 0.10% commission for the trade and 3.00% over or below the RBA rate they are going to make money. In addition to earning profits on commission and financing DMA CFD providers also obtain the benefit of netting all customer positions against each other. Put simply netting means that if a long position offsets a short position the CFD provider has no position, however, as the customer who is long is paying interest and the client who is short is receiving interest less a small haircut, the CFD provider profits from the difference between the two interest charges.
It is important to note that prime brokers won't deal with retail clients themselves and will usually only deal with sizable hedge funds and CFD providers, as such CFDs are an effective way of achieving access to global markets in much the same way as the global investment banks themselves and hedge funds do.
Author Resource:-
Matthew Jones is one of the most experienced DMA CFD traders in Australia. Matthew has been investing for over 15 years and began trading CFDs when they were initially first launched in Australia in 2003. Matthew is a well known CFD trader having dealt with all of the major CFD providers and published a number of courses and learning manuals on trading Market Made and DMA CFDs for a living, including titles such as How to Choose your CFD provider and What is a DMA CFD?.
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