CFDs were developed as a type of equity swap in the 1990s in London. After that, it was introduced to retail traders in the late 1990s. Many UK companies popularized this to see live prices and trade in real time. CFD provider expanded the trading to overseas markets. CFDs are not available in the US. It does not have any expiry date. It can be closed only by making a second reverse trade.
Leverage is we are putting money on an asset hoping of making more and more money. But here, both the profits and losses are magnified and so the risks are too high. It can end up with losing much more than we put in.
Risks in CFD:
When we start doing trading, the risks are very high. So, we have to overcome the risks.
- Investment risk:
Investment risk is when we buy a share which is going long, we can expect a rise in the value of the asset. But, on a short going share, the loss will be high. Since CFDs are leveraged, a small change in the market or government policy will make an impact on our trading outcomes. So, this is the main important risk in CFD trading.
- Counterparty risk:
A counterparty is the one who is on the other side of the financial transaction. The counterparty may be a person or a company. The risk here is when the counterparty sometimes fails to fulfill their obligations. At that time we will face this type of risk. This risk will occur when the counterparty or CFD provider gets some financial problems and they may fail to meet some of the obligations.
- Client money risk:
When we put money on an asset, the CFD provider should separate our money from their own money. They do not worry about the source of money. If they try to misuse the money from the client account, then the money will be ceased to be “client money” and that money will never be protected by the law. The actions of other clients can also affect the safety of our money. Because sometimes, the CFD providers will put all money together in an account, so if one client fails to pay money, then the money in our account is in deficit and there will be no guarantee that we will get the profit for the money we invested.
- Liquidity risk and gapping risk:
Liquidity risk is nothing but the reality of trading on any market. That is, when no other traders are made in the market for the underlying asset, then the CFD which was opened will be processed at a very low price.
Gapping is the basic risk of trading. The time lag between the order we placed and the time it was executed is known as gapping.
Expectation versus reality in CFD:
|CFDs always have high returns or profits.||But, the reality is people often suffer losses more than profits.|
|Easy to learn the skills needed for trading by attending education seminars.||There is a lot of things to be learned by the people thought they attend many seminars.|
|CFDs are very easy and do not require more effort.||CFD trading is not easy and it has to be monitored consistently.|
|CFD trading and online trading are similar.||They are similar sometimes, but the risks of trading CFD are different.|