Trading in general is complex alone, and more when studying specific markets. CFDs are by far one of the trades that’s easy and intricate to understand at the same time. Making it an ideal trade for starting traders and pro traders.
It’s easy in the sense of procedure and execution since all you have to do is buy/sell and speculate on future market movements of an underlying asset. The underlying asset may be commodities, shares, currencies and so on.
To trade, simply register with a trading platform and you’re good to go! And something we forgot to mention, a great thing about CFD trading is how convenient it is. It doesn’t have an expiry date and you don’t have to own the physical asset, just its underlying value.
But for you to trade efficiently, you need to know what makes this market complex! And in a nutshell, it’s the risks and conditions involved. To help you understand what they are AND how to mitigate them, check out everything you need to know about them down below!
What are the conditions in CFD trading?
There are 3 main conditions in this market and its leverage, short selling and asset variety. These 3 conditions are quite significant when trading in the CFD market and to know each one better, here’s a rundown of all 3:
Leverage
When trading with CFDs, this typically involves trading on margin. This is why starting and small traders are attracted to this trade since this allows them to start small and earn big later on. So your initial deposit can be small, but it has to be within the qualified minimum amount (which varies depending on the trading platform.)
And with that small initial investment, CFD trading allows you to open a large position! But a thing you need to remember about leverage is, yes it amplifies profits but also losses, so be careful with it.
Short selling
CFDs allow traders and investors a beneficial way to profit from the downturn in the financial markets. And it’s by allowing them to sell an underlying asset that they do not already own. Do this to later buy it back at a more advantageous and lower price point. With the use of this adaptable financial instrument, traders may profit from market downturns by efficiently shorting assets without having to take actual possession of them.
Asset variety
Since you’re only trading with a financial instrument’s assets, this allows you to trade anything available in the market! So in this market, you can expect VARIETY, may it be commodities, bonds, shares, indices, currencies and so much more. This also provides traders and investors access to various opportunities when trading!
What are the risks in CFD trading?
With conditions come risks, and for CFD trading there are 6 common risks to consider. To know what to look out for when trading with CFDs, here’s a list of its risks:
- Volatility is high in the CFD market – The underlying markets’ price changes have a big impact on CFDs. Rapid and severe price changes can lead to big gains or losses.
- Consider counterparty risk – Contractual agreements with brokers or service providers are necessary for CFD trading. The likelihood of not getting the expected benefits gains if the supplier fails or goes bankrupt.
- Leverage amplification – Your initial investment might be lost if the market swings against you. A margin call will come from your provider, where you’ll be asked to put up more money to keep your position open.
- Intricate products – Understanding many aspects of CFD trading is a must! Since you have to consider tons of things like risk management, market analysis and trading techniques. Inexperience or lack of understanding might result in bad choices and financial losses.
- Overnight costs – Depending on the interest rates and other parameters that the broker has established, holding CFD positions overnight may result in financing expenses.
- Lack of ownership – CFDs are products that are derivatives, therefore you don’t own the underlying asset when you use them. As a result, you are not entitled to ownership benefits like dividends or voting rights.
How can you avoid risks in CFD trading?
Risks will always be there and can arise at any given moment, but there are some ways to mitigate them! Knowing how to avoid risk can potentially help you secure your profit and also maintain a healthy and efficient trading routine. So to help you steer clear of CFD risks, here’s how:
- First and foremost, educate yourself. Know everything you can about CFD trading before jumping right in and trading. Consider knowing this market from its basics to its complexities.
- Practice! Trading is complex and as a starting trader, you need to practice before actually trading. And a great way to do that is by using a demo account to gain experience and master your trading strategies.
- Avoid excessive leverage and consider ONLY investing money you can afford to lose.
- Consider using risk management tools to limit potential losses. An example would be a stop-loss order.
- Stick with reputable, regulated and trustworthy trading platforms and brokers!
- Don’t limit yourself to a single trade. Consider diversifying your portfolio and investing in other markets.