What are CFDs? It is short for Contract For Difference and a widely used instrument for trading. In CFD, there are two parties involved – the buyer and the seller. They go into an agreement that allows both parties to pay the difference of the opening and closing prices of the underlying asset. Moreover, it is a leveraged product which means that the buyer will only have to pay a small percentage of the actual value of their chosen underlying asset. The percentage that the buyer will pay can either range from 3% to 10% at the maximum. This amount is dependent on the broker.
History of CFD Trading
In the early 90s, CFD was first introduced to the world and has started operations at the London Stock Exchange Market. The concept of CFD was first introduced by the firm Smith New Court. At first, CFDs were seen as something like an equity swap that trades on margin. Most of their clients also want to take advantage of the leverage by short selling because they think that it will lower the risks. Due to this reason, CFD has been widely accepted in the market.
First, there is a person-to-person transaction. However, as technology evolved, this type of trading was made easier thanks to the stocking system that allows setting up spread business right from your computer. Although this is banned from other countries, they have their own reasons for doing so.
Types of Risks in CFD Trading
CFDs may be advantageous but some risks need to be considered. If you plan to trade CFD, you must see to it that you clearly understand these risks so you will know how to handle them. After all, you can’t afford to lose the capital you invested and worst, deposit another capital to start trading again.
Investment Risk
The bigger the investment you have, the bigger the risk you should embrace. The biggest investment risk is losing your money which includes the security capital that you have deposited when you first registered for a CFD broker.
Market Risk
Similar to the traditional market, there are also market risks in CFD trading. Investors think that the value of the underlying asset will rise to allow them to choose the long-term investment option. There are also instances wherein a trader hopes for the investment to go the opposite direction, the reason why they choose to take a short position. Traders will try to predict the direction of the market. Sometimes their predictions are right, while there are times that they fail, causing them to lose.
Counterparty Risk
This risk is the failure of fulfilling the financial obligation. The counterparties are the companies or firms that are providing the assets to the investor. If the counterparty risk takes place, you may lose your entire investment.
Leverage Risk
You are well aware of the power of leverage with CFD trading. It allows you to have greater exposure to the market just by paying a part of the actual asset price. But as it mirrors profits, it also mirrors losses. That’s something you should be wary of. Understand what are CFDs and you will be able to counter the leverage risk.
This risk is the failure of fulfilling the financial obligation. The counterparties are the companies or firms that are providing the assets to the investor. If the counterparty risk takes place, you may lose your entire investment.
