The risks of CFDs
General Tips

The risks of CFDs

Are you investing in the stock market? Have you heard about CFDs but don’t know how they work or the risks? Well, this article will attempt to explain everything you need to know.

What are CFDs?

CFDs – Contracts for Difference – are an agreement between two parties, where one party agrees to pay the other the difference in the value of an asset between the time the contract is made and when it is closed. CFDs are a popular investment tool because they allow investors to speculate on the direction of an asset without having to purchase the asset itself.

Risks of CFDs

CFDs are highly speculative, risky financial instruments that are often used for trading on the movements of an underlying asset without owning it. Low industry regulation, the potentiality for a liquidity crisis, and the need to maintain a healthy margin owing to leveraged losses all contribute to their high risk.

 

The risks of CFDs are vast and can result in investors losing a large sum of money if they are not careful. CFDs are contracts that allow you to bet on the direction of an asset without owning it, and these contracts can be traded on margin. This means you only need to deposit a small percentage of the total value of the asset. When trading CFDs, you may experience exponential losses compared to a buy and hold strategy – which would be much safer.

 

CFDs are not regulated by the Financial Conduct Authority (FCA). However, this does not mean that they don’t come with risks. If something goes wrong when buying these contracts, it may be challenging to get your money back. For this reason, you must be fully aware of what you are getting into before investing in CFDs.

 

CFDs on margin

CFDs can be traded on margin, which means that you only need to deposit a small percentage of the total value of the asset. The critical thing to remember with margin is that the borrowed money needs to be paid back, just as a standard loan. If you can’t pay, then your broker will.

 

If the asset price moves against your position, your losses will increase exponentially compared to a buy and hold strategy – which means CFDs are high risk and not suitable for all investors.

 

So, should you invest in CFDs?

Well, that’s really up to you. Also, keep in mind that CFD investments aren’t ordinarily suitable for your ISA or pension – so if you have these sorts of accounts, make sure you’re not breaching any guidelines!

Open an account with a broker

Suppose you still want to invest in CFDs. In that case, It is recommended to open an account with a good broker. Remember that trading platforms or apps that seem too cheap or easy might be hiding something and could lead you to invest more than is suitable for your experience and knowledge.

Some tips:

  1. Don’t use the money that you need for other things. If you have spare cash, then great – but if there’s an emergency and you need your savings, then that is the money that should be available.
  2. Make sure that you understand what you’re buying into – don’t invest any more than you can lose.
  3. Don’t be taken in by promises of high returns in a short space of time (they’re very unlikely to happen).
  4. Beware of something that sounds too good to be true – if it’s much cheaper than all your other options, then it probably is!

Bottom line

Investing in CFDs may be suitable for some investors but is not always the best option – especially if you have a pension or ISA. I would recommend opening an account with a good broker and researching before investing. Remember never to invest more than you can afford to lose, and be suspicious of anything that seems too good to be true.