It has always been a game of calculated risks in pursuit of prospective returns when trading financial products. The trading of contracts for differences (CFDs) is no different. As the popularity of trading CFDs in Canada has increased, so too has the importance of being aware of the hazards involved. Every investor must face the reality that, along with the possibility of large rewards, there is also the possibility of large losses.
CFD trading is a way for investors to make money off of price fluctuations in commodities, indexes, and stocks without actually owning such assets. This fact alone paves the way for the benefits and risks of CFD trading. In a contract with a CFD broker, an investor agrees to trade the CFD broker the difference between the asset’s opening and closing prices.
The ability to leverage one’s position is often cited as a major perk of CFDs. The term “leverage” refers to the ability of an investor to open a position with a value greater than their initial deposit. With a leverage of 10:1, an investor can manage a position worth $10,000 using only $1,000 of their own funds. Gains may be magnified, but so too may be losses. Investors risk losing more than their initial investment if the market moves against their position.
Another inherent danger of CFD trading is the possibility of experiencing a margin call. When a trader uses borrowed funds from their CFD broker, they are said to be trading on margin. A margin call is issued when an investor’s account balance drops below a certain level, usually determined by the broker. The position will remain open pending receipt of the requested deposit. The broker may cancel the transaction if the investor does not meet the margin call, resulting in a loss for the investor.
In addition, market instability poses a potential threat. Many external influences, both expected and unexpected, can affect the direction of the financial markets. All of these things can cause unexpectedly large price swings, which are amplified in the CFD market due to the leverage involved. A seasoned Broker will usually provide instruments to mitigate this risk, such as stop-loss orders, which close a trade immediately if a certain loss level is achieved. However, in very turbulent markets, these orders may not execute at the anticipated prices, a phenomenon known as slippage.
There is also the possibility of insufficient funds. Closing a CFD position may be difficult if there are not enough buyers or sellers in the market. An investor who needs to quickly sell an illiquid asset could suffer huge losses, even if the circumstance is only brief. It is also important to consider the operational risks that are inherent to the trading platform. In a market that operates around the clock, any hiccups, delays, or complete system failures can have catastrophic effects. Although a trustworthy Broker will spend a lot of time and money making their systems as secure as possible, nothing is completely foolproof. Finally, a trader’s demise can come from a psychological risk: overconfidence. The high of a string of winning deals might make a trader feel invincible, encouraging him or her to take greater risks. Overconfident investors can learn their lesson the hard way thanks to the CFD market’s lightning-fast fluctuations.
Given these dangers, why do Canadians still engage in CFD trading? Quite simply, because of the possibilities it offers. Contracts for difference (CFDs) give traders the opportunity to spread their risk, protect themselves from market fluctuations, and profit from both rising and falling markets. Furthermore, a cautious investor who is aware of the risks, who is committed to ongoing education, and who works with a reliable Broker can adopt measures to reduce the impact of these threats. There is potential for substantial financial growth with Canadian CFD trading, but there are also risks involved. With this knowledge, sound judgment, and trustworthy resources, you can have a successful trading career. The old saying goes something like, “knowledge is power,” and in the world of CFDs, that knowledge could very well be your best defense.