We’ve all heard of the advantages that Contract For Difference (CFD) has brought to a lot of traders, newbies or experienced. One great thing about CFD is leverage. With a small investment, you may receive huge returns even equivalent to its underlying asset. This is obviously a good deal for a trader. But truth be told, margin trades do not only spell gains but losses as well. Here are some of the risks involved in CFD trading.
Table of Contents
CFD Trading Risks
· Counterparty Risks
The company providing the asset for the financial transaction is called the counterparty. You do not need to own an underlying asset when buying and selling in CFD trading, the asset that you have is the contract from the CFD broker. Because of this, the trader is more exposed to the counterparties that the CFD broker has business with. If the counterparty cannot fulfill the financial obligations, the trader will be placed in a tough situation.
In case the CFD provider fails to meet the said obligation, the underlying asset that you have from them will become insignificant. Nowadays, there are already a lot of reputable CFD providers offering their business to interested individuals. However, before creating an account, you must check its background first.
· Market Risk
Take note, CFD is a derivative asset. Meaning, a trader can use it to guess the movement of the market, like the stocks. If a trader thinks that the asset value will rise, the trader will have to choose a long position. Meanwhile, if the trader believes that the underlying asset will fall, it is best to choose a short position. This is how everything goes in CFD trading, you hope for the value to move on your favor. However, this is not always the case. Even the most prolific traders cannot predict the movement of the market.
· Client Money Risk
Because of the risks that it involves, trading CFD is illegal in the United States. However, for countries where this form of trading is legal, certain laws protect the investors against the unsafe practices of providers. But then, there are CFD providers who are capable of pooling the client’s money in another account.
· Gapping and Liquidity Risks
Most financial transactions are affected by the market condition, increasing the risks surrounding your investment. Unfortunately, if there are fewer trades being made in the market of your underlying asset, your current contract might get illiquid. During this point, the provider may close your contract at lower prices or require more payments.
What’s the best move to minimize the risks involved in CFD? Use the stop-loss orders. If you want to succeed in trading contracts, you must use stop-loss orders as it is proven to alleviate risks. There are CFD providers who offer a stop-loss order which automatically ends a contract whenever a pre-determined price is met. Moreover, prepare yourselves to face losses and failures along the way. No matter the trading style, there is no particular sure move. You just need to gain better knowledge when it comes to the movement of the market to properly assess if the prices will go up or down.
