How Risky Is CFD Trading?

Contracts for difference have for some time been a vitally important feature on the professional trading circuit. Their ability to afford traders highly leveraged exposure to a variety of markets make them a flexible trading tool, and one that is invaluable to fund managers and professional investors looking to diversify their portfolio. Furthermore, as a relatively inexpensive way to trade on margin, thanks to the comparatively low commission and trading costs, CFDs are used widely in both professional and consumer investment spheres, designed to make larger gains over shorter periods of time.

However, CFDs have a bit of a reputation for being a highly risky trading product, and some financial commentators have even suggested that brokers take advantage of consumer investors who are relatively uninformed of the true risks of trading CFDs. So how accurately does this reflect the true state of affairs, and how much care should you take when trading CFDs?

Trading contracts for difference, like any form of trading activity, can produce unpredictable results that may not necessarily follow any logic or pattern. Even the more well thought out and rationed trade can go wrong, and that's the same with all elements of trading, regardless of the instrument concerned.

One core difference with CFDs, however, is their leverage. CFDs are heavily leveraged to deliver enhanced returns for traders, but this same leverage can also lead to serious problems when trades go wrong. Just as a fractional movement upwards is amplified by many times as a result of trading with leverage, so too are any losses, which can often impinge on other successful trading positions, or even result in a margin call from the broker.

Such is the severity of this downside risk, some analysts have compared the risks associated with CFDs to gambling, even when traders are fully researched and knowledgeable about the markets they are trading. While this is a common concern about CFDs in particular, and there are obvious distinctions between the two, it nevertheless goes some way towards underlining the scope for risk when trading CFDs.

The question then becomes "how best can the risks of CFD trading be minimised", to which the answer is manifold. First and foremost, ensuring you understand the nature of the risks involved, and provided you have taken the effort to calculate your potential exposure to loss, it should be possible to contain the risks of reckless trading. Nonetheless, guaranteeing successful trading is impossible, and it is certain that you will incur losses from time to time as you move through your trading life cycle.

CFDs are, of course, a risky investment, and to plunge in without researching the markets and the trading fundamentals first would be nothing short of madness. No-one ever got rich through sheer guess-work, and only by being totally aware of the true extent of risks you're exposing yourself to through trading contracts for difference can you start to make sensible, informed, investment decisions.