Do you understand the risks with CFD Trading?
LearnCFDs is dedicated to showing you the positive aspects of CFD Trading. However, it is important to know the CFD trading risks when trading Contracts for Difference (CFDs). In particular, it is important to understand
In particular, you must understand you can lose more than your initial balance when trading CFDs due to the leverage involved.
By being aware of the CFD risks you can better arm yourself with appropriate trading strategies that enable you to minimise the risks of CFD trading.
Now if you have been trading for any length of time you would have come to the realisation that trading involves your emotions, mainly fear and greed. In fact, fear and greed are exactly what drive the world’s markets on a day to day basis.
Having said that, most of the risks of trading CFDs are the same fear and greed emotions that fuel problems in share trading, forex trading or futures trading. If you can overcome your emotions, you will be taking huge steps to becoming a better CFD trader and avoiding the common CFD risks.
Top 6 CFD risks to watch out for
- Trading too large after successive wins
- Short selling stocks against the trend
- Trading stocks, FX pairs or commodities you are not familiar with
- Not understanding CFD leverage and the safe use of your account
- Wiping out your CFD trading account…plus some!
Overtrading is a silent killer to any trading account. Many people who overtrade can stay at breakeven for a length of time, and some can even be slightly profitable, but unfortunately many end up in a losing rut, unable to climb out.
The main culprits to overtrading are:
- Trading addiction
- Looking to get back recent losses by placing more trades (revenge trading)
- Several wins in a row can lead to overconfidence and a tendency to want more wins
- Online CFD trading is very accessible at home, work or on the road (mobile phone trading)
- If you have worked hard all your life and then make a move to full time trading the ‘need’ to do work can result in trying to place trades to appear busy.
- Trading costs soar as a result of over trading but the biggest problem can be the psychological damage that is done.
2. Trading too large after successive wins
‘There are old traders, and there are bold traders; but there are no old bold traders’
New traders are warned the worst thing they can do is have some wins early in their trading career.
Winning too big and too soon for many would appear to be a goldmine, but remember the Fear & Greed we were talking about earlier?
Here is a snapshot of what could happen to a new and excited CFD trader.
- Several wins in a row.
- One trade made 3% which resulted in a $500 intraday profit.
- You update your trading spreadsheet and realise if you put four times the amount of capital on that trade, you would have made $2,000 instead of $500.
- Next trade you decide to put this foolproof plan into action
- Welcome to the largest loss you have taken to date plus a good portion of hard fought profits from your first wins.
Confidence hits a new low.
- You back test with renewed enthusiasm, ditching the current entry plan for something better.
- You chase your tail hoping and praying for the next big trade/system to fall into your hands.
- Now this may not have happened to you but surely you know a trader who has done this.
Keep a level head when trading. With or without leverage, there is no future in going for crazy profits on any one trade.
Stay humble and keep learning.
3. Short selling stock against the trend
Hopefully, the CFD risk here stands out like a flashing neon sign, but in case it doesn’t then let me give you a hint.
Shares, CFDs, Forex, Futures and all financial markets have the ability to continue rising for a lot longer than you have capital to fund margin loans.
Have a look at Berkshire Hathaway’s stock price at over $US244,000 a share (as of 18th January 2017).
Chart courtesy of bigcharts.com
What if you thought it was ‘expensive’ at $20,000 and decided to short it?
Say goodbye to that retirement plan.
There is a very old saying: “The trend is your friend…until it bends at the end”.
Don’t fight the trend, especially on leveraged products like Contracts for Difference or else you’ll end up owing a lot more than what you first anticipated.
Don’t marry yourself to a market call. If you are wrong and you attempted to short sell against the trend, be aggressive with your stops. Get out.
4. Trading stocks, CFDs or instruments you are not familiar with
Not everyone who trades leverage products like contracts for difference (CFDs) or options fully understands what they are doing.
To compound this, they take their extensive research on technical analysis (Technical Analysis for Dummies) and attempt to pick the market and trade a product they don’t understand the risks of.
Surgeons, Vet’s and most professional occupations take years of study and practice before you get to work with real patients or clients, so why should trading the markets be any different?
You must research all trading products, trading instruments and understand the risks before jumping in head first.
5. Not understanding CFD leverage and the safe use of your account
CFD leverage is the ultimate double-edged sword. Works brilliantly when you are winning and has the potential to wipe you out when you are losing.
The benefit of CFD leverage is how easy it is to understand and apply to your trading.
An alternative is options trading. To access leverage with options, you need to understand the Greeks, time expiry, time decay and which option series to choose.
Futures have expiry dates, physical delivery if you are not careful (imagine getting a couple of tonne of pork bellies arrive at your doorstep!) and they too come with their own language.
Trading Contracts for Difference is simple. You take a $10,000 position in a stock like Telstra, and you only need around $500 or 5% margin to control the total position. No time expiry, no time decay, no Greeks and no physical delivery.
The CFD risk posed here is when you start winning and then increase the CFD leverage you have. This can be potentially disastrous and could, in fact, wipe out your account, if not more.
6. Wiping out your CFD trading account…plus some!
This is the by far the biggest risk of trading CFDs you need to be aware of. CFD trading, like most derivatives, opens you up to potentially significant losses.
In fact, when CFD trading you may start with $5,000 in capital but take out a $100,000 CFD position.
The market may move significantly overnight, gapping against your position by 10%.
You now have a total loss of $10,000. Your $5,000 has been wiped out, and you now owe $5,000 to your CFD broker.
You can be assured, that $5,000 cheque is not one you want to be writing, EVER.
Always trade within your means and don’t gamble your account.
Opportunities are everywhere when trading the markets, but if you have wiped out your account, you won’t see a nickel of profits.
CFD risks are very real and having a solid understanding before your start trading CFDs could save you thousands of dollars.