Types of CFDs: DMA, Exchange Traded or Market Maker

CFD providers give themselves various names for their style of dealing model they provide – these include direct market access, market maker, hybrid, straight through pricing, straight through processing (STP) and more but in reality there are only three models.

Essentially an investor can take out a contract for difference using one of three models; Market Maker, Direct Market Access (DMA) or Exchange-Traded CFDs. In the market maker model the CFD provider will quote you with its own price for the underlying financial instrument you are trading on. The way providers cover their exposure by hedging and price feeds makes one important difference between the different models – but also the range of markets covered which is much broader with a market maker.

Trading CFDs with a marker maker means that you are basically a price taker. You don’t see the actual underlying market or the market depth which can be a disadvantage as market depth and volumes are good signals in trading decisions particularly for day traders. Market makers do not always hedge client positions with other counter-parties or in the underlying exchange – which may mean that your provider may benefit if you are on the losing end. On the more positive side market makers are able to offer extra functionality like guaranteed stops (not available on DMA) or quote a much wider range of markets than a DMA broker – and currencies, commodities and indices can only be dealt this way since there is no central exchange.

If your CFD provider operates using the Direct Market Access (DMA) model, then you will be placing your orders directly in the underlying exchange when you take out a contract for difference. This means that the provider will automatically hedge all placed client positions. You can watch the actual underlying market prices and see your order being executed via Level 2. You also get to see other market participants’ orders irrespective if these are buys or sells. So for instance if you want to check a share CFD on the London Stock Exchange you would see the same prices as every trader who trades on the underlying LSE exchange and not just your provider’s price.

Trading via this route makes you a price maker. The real cost of trading without DMA can be hidden as it can be difficult to check the pricing if the spread is unknown or variable. The DMA method is thus more transparent and less subject to abuse than the Market Maker model but on the downside the range of markets offered is quite limited – usually to a limited number of stocks. Because of this if you trade with a market maker, it is still a good idea to check the prices on a DMA platform (which would display the actual market prices) as a reference point to compare against the prices from a market maker (although of course this applies only for markets like stocks that have a central clearing house).

The third method consists of exchange-traded CFDs, which presently are only available in Australia via an authorised broker. These are limited to blue chip stocks like BHP Billiton, Amcor, Woolworths and Wesfarmers. The exchange-traded CFDs model comes at a much lower level of counterparty risk as they utilise the ASX clearing house; the contract for the buyer and the seller is with the clearing house.

IG Markets claims that around 89% of CFD providers are market makers while just 20% offer Direct Market Access. Meanwhile, research from specialist marketing company Investment Trends showed that less than 5% of CFDs are exchange traded.

Note: With a CFD broker like IG you can trade a huge range of markets all fromone account, DMA equities, good and more stable pricing and low margins and contract sizes. Personally, for me since the demise of MF Global it is only really IG Markets (the CFD arm of IG) that offer DMA trading and at the end of the day if I were trading multi asset OTCs then I wouldn’t bother trying to use anyone else.

The first two systems trading are known to as over-the-counter CFDs, where the contract is an arrangement between you and the provider where you are both counterparties to the trade.