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Types of CFD Providers
Traders in Contracts For Difference can distinguish between two main types of CFD providers, this distinction is broadly based upon the order activity flow when a CFD trader buys a CFD from the provider. The two main types of providers are:
- Brokers (intermediaries or agents)
- Market Makers
Some CFD providers do actually merge the both functions.
Contracts For Difference Brokers
CFD brokers (CFD agents or intermediaries) offer trading services for investors and charge a commission based on providing these services. CFD brokers hedge their contract with the trader by creating the same transaction of the investor's CFD order in the underlying market, therefore, the CFD brokers assume a riskless investment based on this order flow.
Example: When a CFD investor decides to buy 200 BT shares, he will contact a broker, this latter will buy 200 BT shares from the London Stock Exchange. The broker will then provide the investor with a position in the stock and maintain at the same time a riskless position. The CFD broker will hold these 200 BT shares until the investor decides to sell his share CFDs, only then, a reverse in the position between the investor and his broker will take place, the investor will ask the broker to sell his BT shares (low or a high), the broker will sell these shares on the London Stock Exchange and at the same time buys these 200 BT shares from the investor to close the position.
A commission fee is charged for trading with the broker and another fee is charged by the broker for holding the BT shares for that period of time (this charge is call financing cost).
Market Maker
While the Contracts for Difference brokers earn commissions on the CFD transaction with their clients, the market makers make their profits from the bid-offer spread they inflict.
The market maker is the second type of CFD providers; this provider unlike the brokers assumes the risk of the investment by engaging positions as a result of investors' order flow. Contracts for Difference market maker impose a customized price quotes for traders to execute their transactions with.
The spread bid-offer imposed by the market maker is dictated by the best execution requirements of the European regulatory service, these spreads 'width depends generally on the volatility and the liquidity of the underlying market.