ASX CFDs And Their Advantages
What’s a Contract for difference?
A CFD (Contract for Difference) is an agreement between a buyer and a seller to exchange the difference in value of a specific instrument between when the contract is opened and when it is closed. The difference is determined by reference to an underlying instrument which is usually a security, index, currency or commodity and the period over which the Contract for difference is held.
CFDs are geared instruments. This means that you are fully exposed to price movements of the underlying instrument without having to pay the full price for that instrument. Leverage means that CFDs offer the potential to make a higher return from a smaller initial amount than investing directly in the underlying equity.
Leverage, however, typically involves more risks than a direct investment in the underlying share. It is vital to recognize that this effect may work against as well as for traders. The use of leverage can lead to large losses as well as large gains.
Benefits of trading CFDs
CFDs have been used by skilled investors for over twenty years and emerged originally as an over-the-counter (OTC) product. CFD associated trading and hedging is one of the fastest developing areas in the Australian and European derivatives markets. This acceptance has arisen as a result of the following main features:
Leverage
CFDs enable you to gain full exposure to a share, commodity, Currency or index for a fraction of the price of buying the underlying. CFDs call for only a small initial margin to secure a trade.
The ability to go ‘short’
CFDs allow traders to take advantage of falls in prices. This means that investors can benefit whilst prices are going down, not just up. CFDs are thus an excellent investing and hedging instrument.
Ease
Non-expiry: The majority of CFDs do not have an expiry. They are perpetual in nature. For CFDs that do not expire, the only way to close a position is to trade the opposite side of the position.
The CFD mirrors the value of the underlying: Unlike other types of derivatives (i.e. options and futures), cash flows such as carry costs and dividends are not mirrored in the cost of a CFD. Instead, cash flows are paid whilst the trade is open, allowing CFD prices to track the underlying instrument rather than trade at a reduction or premium, as can be the case in other forms of derivatives.
Advantages of ASX Listed CFDs
Market Independence
ASX is required under the Corporations Act to guarantee that its markets are fair, orderly and transparent. ASX ensures a sound operational and front-line regulatory environment for its exchange-traded markets and clearing and settlement services, providing effective systems and infrastructure together with services intended to maintain and improve the integrity, performance and effectiveness of its trading, clearing and settlement facilities. For the ASX Listed CFD investor, this means being able to participate in the market with confidence.
As the central market operator, ASX is independent of the parties with whom you are receiving advice and dealing through enabling it to act fairly and impartially. This separation of responsibility between broker and exchange also provides customers with choice as to whom they wish to effect their business through.
Having a central market also means there is one typical contract specification for all ASX Listed Contracts for difference, not a different product based on who you execute through. It’s a fundamentally superior Contract for difference market.
Transparency
Transparency is a main ingredient in a well educated market. ASX reports on all ASX Listed CFDs transacted, open positions, bid, offers and their volumes. In fact, all the market information you are used to seeing from the ASX. This means a better informed market.
ASX Listed CFDs are traded in the same way as any other ASX traded contracts:
1. All prices are formed in a completely transparent method in the ASX’s CFD central market order book. Each trader’s order is combined in the ASX Listed CFD central market order book with those from other market participants, including market makers, and becomes an integral part of the price discovery process.
2. All trades are filled on a strict price/time priority. Price/time priority means the first person to enter the best price is traded against first. This results in everyone in the central market order book being dealt with equally and consistently, no matter how big or small a trader you are.
3. Notably, whilst prices are transparent, the individual trader remains anonymous, which minimizes market impact expenses (especially those related to others identifying an individual’s trading patterns and trading ahead of him/her).
4. Any person can place into the market a better bid or offer, as is the case in all exchange based markets. No-one is required to accept the price obtainable in the market. However, once an order is filled, you are committed to settle the trade. All prices in the market are firm in the amount indicated.
5. The ASX Listed CFD central market order book incorporates orders from market makers. Their actions help make certain the ASX Listed CFD market has competitive prices and deep liquidity.
Risk Management
ASX Listed Contracts for difference operate in a centrally cleared marketplace. The Clearing House provides central counter party clearing for the ASX Listed CFD market. This involves the Clearing House managing risks to make certain that the interests of its Participants and customers are protected and that the integrity of the marketplace is maintained.
Utilising a method called novation, the Clearing House becomes the principal to all trades and liable to perform against all contracts to which it is a party and effectively ‘guarantees’ performance to other Clearing Participants. Novation and thus the clearing guarantee become effective on registration of the agreement between a buyer and seller.
This exposure is then managed and the clearing guarantee implemented in a number of ways. Initially this is achieved by the collection of the various margins. The collection of these moneys protects against severe price movements and prevents participants from accumulating large unpaid losses that could possibly impact on the financial position of any other market users. This is a main element that differentiates exchange-traded markets from over-the-counter (OTC) markets, where such a strict margining regime is not in place.
The ASX Listed CFD market also has access to the Clearing Guarantee Fund meant for use in the event of failure of one or more Clearing Participants.
Trading in the ASX Listed CFD Market
When trading ASX Listed CFDs, your order is entered directly via a market member into the ASX Listed CFD central market order book. This order book is available for the market to see. All orders are executed on a strict price/time priority. This means that the initial order with the best bid or offer price is always filled first. Dealing in the ASX Listed CFD central market order book also ensures “customer orders” are always given precedence above a broker’s “house orders”.
In contrast, traders executing CFDs using an Over-the-counter broker, do not have their orders in the ASX Listed CFD central market order book. Customer orders are transacted with the OTC CFD counterparty (typically described as a CFD Broker). The customer’s order is not protected by the ASX’s price/time priority or customer order priority rules.
To find out more about ASX CFDs you ought to download this CFD ebook which explains ASX contracts for difference in detail including how they are margined, priced, cleared and how you can go about finding a broker that is able to offer you the world’s first exchange listed CFD contract.
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