Investing in Contract for Differences (CFDs) may initially seem like the best option, especially for beginner traders or those with less investment capital. However, it is important to note that all products traded on margin carry a high risk level and the potential for greater loss than the initial deposit amount. Although most CFD providers do incorporate great stop loss options to limit traders’ losses in the event of market gapping, there is no guarantee that the stop order will be completed at the price level requested, potentially meaning a loss greater than the trader’s initial investment. Those brokers that do claim guaranteed stop loss orders often charge astronomical prices for doing so. Also, since CFD providers have the power to create their own prices, there may be times (particularly in high volatility situations) that prices vary from the actual value of the underlining market price.

Below are some of the most notable disadvantages when trading CFDs:

Price Requotes

Market makers are the most common type of CFD providers and often confirm executed trades at a different price than the bid/offer shown. However, price requotes and price spread crossing does not usually occur with Direct Market Access, which is sometimes included with market makers.

Even if a provider maintains a “no requote” policy, there are circumstances in which a trader may not receive an order execution at the requested price level and, in such cases, orders are executed at the next available price. This can lead to big losses for those unprepared for the price shift.

Although Direct Market Access can be helpful, CFD traders have no real guarantee that an order will be carried out at a requested price.

Margin Calls

CFDs require sufficient backing in order to support an open position. If the market moves against the trader’s position, margin levels are increased and may require the deposit of additional funds to maintain the trading position open. If the trader fails to comply with the CFD provider’s request within the preset time, that provider may close out the position and leave the trader liable for paying any additional amount owed for the transaction.

Additional funds are required to cover losses when facing a margin call.

Leverage Inflexibility

CFD providers set applicable and appropriate margin levels for each financial market, creating very poor transparency in a transaction. Traders must agree to these leverage levels and develop risk management strategies based on this level. However, a trader’s leverage level can be modified if the CFD provider allows the change. Changing the leverage level could also increase the margin requirement.

Traders are generally stuck with whatever leverage level is set by the broker.

Less Suitable for Long-Term Investors

A trader’s open positions are penalized with overnight financing charges calculated daily and based on the contract size. For those traders who hold long positions for extended periods, this can be disastrous to a trading portfolio since it makes ROI far less predictable or effective. Conversely, for those traders who prefer short positions, payment of full interest or the asset’s dividend value may be required, exposing that trader to unlimited loss potential.

CFDs can potentially cost a long-term trader a hefty sum due to financing fees.

No Ownership Rights

Since a CFD is an over-the-counter derivative product, there is no physical ownership or “location” of the underlying asset. Therefore, a CFD trader has no shareholder rights and has no option to transfer the trading position to a different CFD provider.

The CFD-holder is not a product owner, so he/she has no investor rights (except for dividends).

Rate of Interest and Exchange

Currency- and interest rate-based CFDs are exposed to high loss risk if a sudden rate shift occurs, and it is critical to remember that profits or losses on overseas-index CFDs are denominated in the underlying asset’s currency.

Sudden rate changes can lead to serious profit loss, as CFDs are denominated in the underlying asset’s currency.

High-Risk Products

The high margin levels for CFDs classify them as a high-risk product.  Leverage acts as a double-edged sword, maximizing the trader’s profits but also increasing potential losses. If a trader uses an excess of leverage, a small movement in underlying price can mean losing more than the trader’s initial investment, which can end a trading career very quickly.

High risk status can maximize profits, but it can also drastically increase losses with just a small amount of movement.

Bottom Line

There are benefits to using CFDs, but there are also many serious disadvantages as well, and these must be carefully considered prior to engaging CFD trading. Weigh the risks involved, such as interest charges, poor transparency, lack of investor rights, little or no leverage flexibility, and requote problems. Traders who do not weigh the options risk serious financial loss, even if they have many years of experience.

 

Summary

P

Although Direct Market Access can be helpful, CFD traders have no real guarantee that an order will be carried out at a requested price.


P

Additional funds are required to cover losses when facing a margin call.


P

Traders are generally stuck with whatever leverage level is set by the broker.


P

CFDs can potentially cost a long-term trader a hefty sum due to financing fees.


P

The CFD-holder is not a product owner, so he/she has no investor rights (except for dividends).


P

Sudden rate changes can lead to serious profit loss, as CFDs are denominated in the underlying asset’s currency.


P

High risk status can maximize profits, but it can also drastically increase losses with just a small amount of movement.


Share:

Comments

There are currently no comments, be the first to post one!

Leave a Comment!

Only registered users may post comments.
nike free run 5.0 baratas nike roshe run mujer online comprar nike roshe run baratas nike free run 3.0 v5 nike roshe run baratas china nike roshe run baratas nike free run 3 mujer baratas nike roshe run baratas mujer zapatillas nike free baratas zapatillas nike roshe run baratas zapatillas nike free 5.0 zapatillas nike roshe nike free run outlet comprar nike roshe run nike free run 5.0 baratas nike roshe run baratas españa nike roshe run mujer baratas nike roshe run comprar nike free run 3 5.0 nike free 5.0 baratas comprar nike free 5.0 nike roshe baratas online nike free run 3 mujer baratas nike roshe run baratas online nike roshe run hombre baratas nike free run baratas nike run roshe baratas nike roshe run mujer baratas nike free run 3 mujer baratas nike free 3.0 flyknit