Trader Tip: Understanding CFD Price Feeds From time to time we get questions on specific topics of interests from many traders, and we thought we would take a moment to discuss price feeds of CFDs (Contract for Difference). The specific question to answer is, “Why is there a difference in price with various broker’s price feeds?” As a way of a refresher, let’s first look at what a CFD is.
A CFD is a tradable derivative instrument that mirrors the movements of the asset underlying it. It allows for profits or losses to be realized when the underlying asset moves in relation to the position taken, but the actual underlying asset is never owned. Essentially, it is a contract between the client and the broker. CFD trading enables you to speculate with margin on the rising or falling prices on instruments such as shares, indices, commodities and treasuries. CFDs will be priced according to the underlying index level or based on the futures (or cash) price as adjusted for fair value. CFD brokers acts as an agent on behalf of their clients. In other words, they are not necessarily risk-takers but instead look to hedge their CFD transactions in the underlying futures or cash markets.
So getting back to the original question, if the underlying instrument price is theoretical the same should not the price of the CFD be the same across all brokers? Well, if you have read carefully we have already touched on the answer in the definition of the CFD. We can look at the following basic reasons and understandings for potential price differences:
- The CFD may be based on the underlying cash or futures price – which is obviously different. Most brokers prefer to track using the futures, as the cash markets are not always 5×24 and hence would have to close their markets and suffer price gaps when the market opens after a trading session. The limited cash market’s open times would also lead to less trading (and profits for the broker … ;-).
- If the CFD is based on the underlying futures price, price will track the futures identically. But remember futures expire and one would need to be aware that you could get trapped in a trade at expiry, being forced out of the trade at a bad and/or wide-spread price.
- Due to the potential problems identified in point 2, many brokers chose to have a sliding scale in pricing to ensure there is a seamless price and not have CFD contract expiries. This means as the futures move toward the expiry date in time, the futures price meets the cash price. Note that this sliding scale is not linear and forward and backwardation of the futures are incorporated into the price feed’s price formula.
So does it matter which CFD price feed mechanism the broker uses in our trading? Mostly no, as the ADR (Average Daily Range) will be the same. For the most part, price will move at the same Pip difference as its underlying instrument, though not at the same price – depending upon the brokers choice of price feed. That being said, when doing trade analysis and you are not understanding these CFD price differences, you may think price has broken some price support/resistance level when in fact it has not. It has merely had a futures contract roll over, giving this appearance on the trading chart.
So we hope this helps a little in the understanding of CFD potential price differences. Please see below a video presentation of this Blog post. If you have other questions you would like answered in this format, please do not hesitate to send us potential future Trader Tip topics.
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