Index CFDs and Spreads

Many traders and investors new to CFDs frequently hear the word spread talked about 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 practically all exchange traded and over the counter (OTC) products however it is not an expression often used by share traders but more commonly talked about when discussing index and forex CFDs.

The spread of share CFDs are often the same as the spread of the underlying security over which the CFD is derived however when trading shares this is often known as the bid and ask price. A number of CFD providers may widen the spread of share CFDs when there is a lack of liquidity in the underlying instrument on which the CFD is derived, others may factor their commission charge into the spread. When choosing a CFD broker it is vital that you make sure the spreads of the share CFDs offered emulate the spread in the underlying share. Often CFD brokers that widen the spread of CFDs over liquid shares as well as charging a commission are earning extra income by benefiting from their client's lack of knowledge of the price of the underlying instrument on which the CFD is quoted.

Spreads are also often applied to Index CFDs. The spreads applied to index CFDs work very differently to the spreads applied to equity CFDs in that some 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 often 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 differ depending on 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 is a vast quantity of liquidity and spreads tend to be very tight. It is 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 is common for CFD providers to differentiate themselves from by quoting variable or fixed spreads, however both have their advantages and disadvantages.

When trading 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 calculate their profit or loss accurately without being at the mercy of the CFD provider. Trading forex CFDs on fixed spreads can be beneficial over variable spreads especially in periods of volatility where providers offering variable spreads will show exceedingly wide spreads, however trading during times of low volume will cost more. Fixed spreads tend to be suited to forex scalpers or day traders who trade actively during volatility.

Dealing in forex on variable spreads also provides benefits for the reason that traders are often able to enter the market during quite times at better prices, however all traders should beware that variable spreads are not always advantageous 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 position was opened. Variable spreads are suited to longer term strategy traders who do not trade during volatile periods.

In conclusion it's important that as a newbie trader you understand how CFD companies can use the spread to their benefit. As always it is important to make sure that you go for a CFD broker that is able to give you CFDs which will fit your trading plan as the wrong choice could be an expensive learning experience.

Article Source: http://casinoarticles.us

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

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