So for all those who are unaware of CFD trading I’ll give you a brief overview of what CFD trading is and how it works. CFD trading is a contract for differences trade which allows a trader to exchange the differences in the value of a financial product from the time that the contract opens till the time the contract closes. In this type of trade the trader doesn’t actually own the underlying asset and these types of trade are mainly attractive for all the day traders who can easily make use of leverage to trade assets that are mostly very costly to own. CFD trading is considered to be very risky due to lack of any industry regulation, potential lack of liquidity and the overall complexity of the trading. Let’s explore the different types of CFD trading risks.
What are CFD trading risks?
There are several types of CFD trading risks let’s go over a few of them to understand what they are and how they work.
1. Counter party risks:
These type of risks involve a counter-party which is mainly the company that is providing the asset in the financial transaction. Whenever a trader is buying or selling a CFD the only asset that is being traded is the CFD contract which is issued by the CFD broker/ provider. Thereby, this exposes the trader to other counter parties of the CFD provider which are mainly other customers the broker is working with.
The main risk is that the counter-party fails to fulfill the financial obligations. If the CFD provider fails to fulfill the obligations then the underlying asset is not relevant. Whenever a person decides to trade in this industry it is pivotal to conduct a thorough research on the brokers credibility as this industry is highly unregulated.
2. Market risks:
These risks are mainly associated with the dynamic environment of the CFD industry which is mainly the unexpected information, changes in the market conditions and government policies that result in the value of an underlying asset to change rapidly. Thereby, these small changes have major impacts on the returns and the trader will have to close the position if their margin calls are not met.
3. Client Money risk:
In CFD trading, several countries have client money protection laws that are present to protect the investor from any harmful practices of the CFD provider. According to these laws, any money that is transferred to the CFD provider must be segregated from the providers money to prevent the provider from hedging their own investments. In addition to this, the law also prevents providers from pooling the clients money into one or more accounts. Thereby, these laws prevent clients and traders from losing all their money from the client money risks.
4. Liquidity risks and gapping:
As it is evident that the CFD industry is very dynamic, market conditions effect financial transactions and hence may increase the overall risk of losses. When the market does not have enough trades being made for the underlying asset, the contract becomes illiquid. The CFD provider can easily close the contract at lower prices or require additional payments.
Another risk is gapping which is the decrease of the price of a CFD due to the dynamic nature of the market however the trader will have to pay the same amount and incur a loss.
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