4 Common CFD Trading Risks and How to Avoid Them as a Novice Trader
CFD trading is one of the most popular markets today due to it allowing traders to venture into other markets quickly and easily. This trade is a financial derivative that gives investors a chance to take ownership of an underlying asset without owning its physical form.
Like its name “contract of difference”, you make trades through contacts and in any market you like whether it’s stocks, forex, commodities, precious metals, bonds and so much more. To profit, all you have to do is speculate and if the market shifts in your favour, you gain.
But although CFD trading overflows with advantages, it’s also just like any other trade, it’s volatile. And as a starting trader or someone new to CFDs, you need to know what to look out for, how to reduce the risks and how to handle them.
To help you out, below are a list of 5 CFD trading risks and how to minimize the chances of facing them:
1 – You might face counterparty risk
A risk that’s commonly experienced by traders is the counterparty risk. Now, what is a counterparty risk? In a financial transaction, the counterparty is the entity that delivers the asset. The contract provided by the CFD provider is the only asset exchanged when either purchasing or selling a CFD.
And with that, this exposes the trader to the counterparties the CFD providers execute trades with. This is where the risk is when the associated counterparty fails to fulfil its financial obligations. You will be affected if the provider is unable to fulfil its commitments since at that point, the value of the underlying asset will be irrelevant.
How can I avoid this?
A way to effectively reduce the risk of facing this is by doing your research about the provider. In CFD trading and the market, know that it isn’t highly regulated, so all you have to do is identify if a provider is trustworthy by checking their credentials, reputation and reviews.
2 – CFD trading might be too complex for new traders
Another common thing most new CFD traders face is how complex this trade can get, and with that might lead to more harm than good. So even if you did your research on CFD trading, and have been watching and reading about it a lot, it can still be complex to grasp once you actually start trading.
How can I avoid this?
A way to avoid the risk of facing the confusion of CFD trading is by using a demo account first. A demo account can help you practice trading without the risk. All you have to do is look for a provider that offers a good demo account and start practising.
Demo accounts give traders the ability to experience trading and practice on actual tools, charts and so on. This can help you practice your strategies better and know your way about the market.
3 – You might get carried away!
A common mistake made by all traders whether you are new or not, is getting carried away when trading. This is a dangerous thing to let slide since it’s something you won’t also notice until later on. And to prevent this from happening in the future, you need to practice your discipline.
How can I avoid this?
Since discipline is something you need to learn along the way, there is an effective way to help you with this risk right here and now and it’s using a stop-loss order. This is a type of order traders place to secure profit without getting carried away.
How this works is, you’re asked to set 2 prices: stop price and limit price. The stop price is when your market reaches your set limit, your position automatically closes securing your profit and minimising the risk of a loss. The limit price is a price that’s below your limit which signals your position to stay open.
4 – You will face market risks along the way
Market risks are something you can’t avoid, even the most experienced and educated trader still faces this risk from time to time. And even with a concrete trading strategy, if you face a market risk you can expect your position to be closed or given a second margin call.
To keep a position open, you need to have a minimum balance in place and when you lost that, the provider will either close your position or ask for a second margin call (to keep your balance within the “margin.”)
There are tons of factors that make up market risks such as interest rate risks, equity risks, commodity risks and currency risks. So when a market risk comes your way all you have to do is be prepared.
How can I avoid this?
To avoid or lessen the damages when faced with market risks, an efficient way to keep your position open is by being prepared for rainy days. Always have a backup plan when trading and make sure your backup money is enough to meet margin requirements.
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