CFD trading tips and tricks - Spreads

Numerous traders and investors new to CFDs often hear the word spread mentioned by their CFD provider and ask me what it means. In brief the spread is the difference between the bid and ask price of the CFD. Spreads exist across just about all exchange traded and over the counter (OTC) products however it is not a term frequently utilized by share traders but more commonly mentioned when discussing index and forex CFDs.

The spread of equity CFDs are often the same as the spread of the underlying security on which the CFD is derived however when share trading this is often known as the bid and ask price. Many CFD providers may widen the spread of share CFDs when there's a lack of liquidity in the underlying instrument over which the CFD is based, others may factor their commission charge into the spread. When choosing a CFD provider it is essential that you ensure the spreads of the share CFDs offered emulate the spread in the underlying equity. Often CFD providers that widen the spread of CFDs over liquid shares in addition to charging a fee are earning additional income by benefiting from their client's lack of understanding of the price of the underlying instrument over which the CFD is quoted.

Spreads are also often applied to Index CFDs. The spreads applied to index CFDs work very in a different way to the spreads applied to share CFDs in that a number of CFD providers will offer CFDs over index futures contracts even when the exchange on which they're traded is closed. Often the price of an index CFD is based on the fair value of the futures contract or cash price, CFD providers will take the price of the index and add a spread which is frequently wider than the spread in the underlying index futures contract. When the exchange on which the futures contract is quoted is closed CFD providers will often widen the spread as they are not capable of hedging their customer orders. The spreads applied to index CFDs will vary according to the exchange and liquidity of the underlying futures contract.

The spreads applied to forex CFDs work in a similar manner to the spreads applied to index CFDs however as the forex market is the biggest market in the world, there's a vast quantity of liquidity and spreads are often very tight. It is very important to be aware that some CFD providers will take advantage of forex traders by quoting tight spreads for small trade volumes or during quiet market periods, but widen the spread during busy periods or when the trader becomes more active. It's common for CFD providers to differentiate themselves from by quoting variable or fixed spreads, however both have their advantages and disadvantages.

When buying and selling forex CFDs with fixed spreads traders don't have to worry about being re-quoted or spreads widening over periods of high volume, they are also able to work out their profit or loss accurately without being at the mercy of the CFD provider. Trading forex CFDs on fixed spreads can be advantageous over variable spreads especially during times of volatility where providers offering variable spreads will show exceptionally wide spreads, however trading in periods of low volume will cost more. Fixed spreads are often suited to forex scalpers or day traders who trade frequently during volatility.

Dealing in forex on variable spreads also offers benefits for the reason that customers are often able to enter the market during quite times at better prices, however all traders should beware that variable spreads are not always beneficial for the reason that should the trader want to exit the trade the CFD provider may show a wider spread than the spread shown when the trade was opened. Variable spreads are suited to longer term strategy traders who do not trade during volatile periods.

In conclusion it is vital that as a newbie trader you understand how CFD companies can use the spread to their advantage. As always it is important to make sure that you select a CFD broker that is able to give you CFDs that will fit your trading strategy as the incorrect choice may well be a costly learning experience.

Article Source: http://gamblingarticlessite.com

The author Ben McGrath is a professional Contract for difference trader. Ben deals with Australia's most popular Contract for difference provider IC Markets. Ben has published a number of textbooks and guides on CFDs, you can download his most recent guide to CFD trading and understand more about CFDs for free.

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