C no evil, Fear no evil, Deal no evil…dispelling the myths of CFDs
CFDs have been a hot topic in the mainstream press recently after the Australian Securities and Investments Commission (ASIC) released its long awaited review of the CFD industry. ASIC is Australia’s corporate, markets, and financial services watchdog. It is charged with the responsibility of protecting consumers with their dealings with any of the above.
In the lead up to the ASIC review there had been much noise against CFDs from mainstream share brokers, a financial press bent on sensationalising the potential pitfalls of CFDs and the odd punter who had done their shirt trading the product.
Mainstream brokers have felt threatened by CFDs since they first appeared in Australia around 2002. Discount brokers especially were quite vocal in their initial opposition to CFDs until they realised what a tour de force CFDs were proving to be for retail investors in accessing the market.
CFD providers were offering trading platforms which had functionality well in excess of anything the discount share brokers were (and still are) offering, and generally for free when many brokers were charging significant amounts for similar features. The biggest thorn in the discount brokers’ sides was the cut-price brokerage charged by CFD providers: most minimum dealing rates start at around $10 a transaction; around half the price of Commsec’s best rate and up to one-third of Etrade’s. The retail trading and investing public finally had a choice – and they flocked to CFDs.
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The two main players in the early days of Australia’s CFD industry were of course CMC Markets, who held an initial dominant market share of the burgeoning market, and IG Markets, who has recently overtaken their old rival as the most used CFD provider in Australia. Each offered an “over the counter” product where traders were trading with and (effectively in many circumstances) against their CFD provider. This structure is a “market maker” model where the CFD provider defines all parameters of the trade. History shows that the rise of one CFD provider, and the relative fall of the other, may come down to how each dealt with this important responsibility; that is, the decision to take the other side of the client’s trade or not…
Discount share brokers were quick to realise how lucrative the CFD market was and wanted in on the action. But rather than join forces with either of the CMC-IG duopoly (make no mistake, they considered it), the brokers chose to embrace an Australian Securities Exchange (ASX) “listed CFD” alternative (also known as exchange traded CFDs).
The ASX had also vehemently opposed CFDs initially because they were market made, arguing that an exchange model would be more open and transparent. But ironically, when the ASX realised that market markers were integral to the process of exchange traded CFDs, they ended up with a product also reliant on market makers; the pricing of the ASX’s exchange traded CFDs are 100% beholden to the market makers and their discretion. The ASX alternative has since languished on a relative basis and the vast majority of CFD industry experts have labelled them a poor interpretation of what CFDs are supposed to be to investors; offering broad-based, easy and cheap access to the world’s markets.
So presently we have the ASX’s exchange listed CFD market, which is supported by the large discount brokers and also anointed with ASIC approval in its latest review, and the incumbent CFD market makers, which are ASIC’s main target. Remember, both models are market made. Traders are going to have to pay their pound of flesh to trade either way. In fact, the market makers in the exchange traded version of CFDs mirror the exchange traded options (ETOs) market makers, traded on the ASX’s options exchange. Anyone who has traded ASX options will know that these instruments come at a price. Exchange traded or not…
Traders should know that the market makers who are employed to facilitate ASX’s CFDs are large banking and financial services institutions staffed with experienced professional traders. Retail investors are therefore trading in direct opposition to these firms, which have an obvious and distinct advantage. As one would naturally expect, market makers don’t work for charitable organisations and most can be relied upon to put themselves before the retail investor.
The alternative, the common over-the-counter market made model for CFDs, has been unfairly tarnished in much recent commentary. Yet the main criticisms of this model don’t stand up to basic analysis. At least one CFD provider, IG Markets, offers Guaranteed Market Prices. Thus IG guarantees that for ASX listed equities their clients will always trade at the underlying market price. This means that whilst you are in effect trading with a market maker, they are bound to reflect exactly the prices on the ASX. This approach contradicts the unscrupulous measures claimed by most mainstream brokers and the press regarding over-the-counter offerings. In fact, this particular market made approach is far superior to the exchange traded model, because not even ASX exchange traded CFDs can offer guaranteed market prices.
Unfortunately a mature analysis on how CFDs actually work has been missing. Instead of rational debate, some sections of the press have found it easier to push emotional buttons than to report the cold hard facts and educate punters about CFDs; only a few specialised investment publications seem to bother with the finer details of the products. Most media has over-exaggerated the risks of CFDs, arbitrarily labelling them “high-risk”. Yet, with a little research and a calm and objective head, this could not be further from the truth.
CFDs aren’t evil; they’re just another trading product, with intrinsic opportunities and risks. They won’t evaporate your life savings at the push of a button unless you are ignorant to their risks and good trading practice in general. There aren’t any victims of CFD trading, just those who make bad trading decisions and as a direct result, lose their money – the same scenario which causes traders and investors to lose money on shares, options, futures, warrants and a host of other financial products.
Do your own research, be informed and get educated before trading CFDs and take responsibility for your own actions.