CFD trading risks: What to look out for when trading leveraged products

Trading leveraged products can be lucrative, but there are many risks to watch out for.

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A Contract for Difference (CFD) is a highly leveraged, complex product that is ideally suited to very experienced traders and investors. CFDs can be highly lucrative and provide an opportunity to make a lot of money quickly, but you can also lose a lot of money just as quickly if you’re not experienced.

This guide covers the risks involved with CFD trading.

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Disclaimer: Trading CFDs and forex on leverage is high-risk and losses could exceed your deposits.

What is CFD trading?

CFDs allow traders to speculate on the value movements of a large range of financial products and assets – anything from share prices and currency pairs to the price of gold or oil. CFD traders do not own the underlying asset nor are they trading the asset itself but are instead speculating on whether its value will increase or decrease. For more information on CFDs, check out our guide: What is a Contract for Difference (CFD)?

What are the risks of CFD trading?

CFDs can seem appealing as you have the potential to earn a lot of money quite quickly. This is because they are highly leveraged, so even though you only need to put forward a small margin of the complete trade value to initiate a trade, you can still benefit from 100% of potential gains. But there are many risks involved, which are detailed in this section.

  • CFDs are complex

CFDs are complex products so there’s room for misunderstanding and trading errors. While investing in shares is a strategy suited to both new or experienced investors, CFDs are best left to highly experienced traders.

  • You could lose more than your initial capital

If you put $50 into a pokie machine, the most you stand to lose is $50. However, with CFD trading you could lose more than you originally invested. Trading CFDs is more risky than traditional share trading as you’re trading with leverage. Traders are only required to put forward a small amount of the total trade value, often only 5%. However, if the trade goes in their favour, they are entitled to 100% of the profits. But the reverse is also true: traders are responsible for 100% of the losses too. Let’s look at the fictional example below, courtesy of ASIC’s Moneysmart website.

Imagine a trader buys 4000 CFDs at $5 per order, for a total of $20,000. The CFD has a margin of 5%, meaning the trader only pays $1000 to open the trade (ignoring possible commissions). The trader believes the price of the share will rise in value, so they go long on this trade. If the price of the underlying share the CFD is speculating on rises or falls in value, the table below shows possible gains and losses.

If the price of the shareToYou could gain
Rises by 20%$6.00$3934.00
Rises by 10%$5.50$1937.00
Rises by 5%$5.25$938.50
If the price of the shareToYou could lose
Falls by 5%$4.75$1058.50
Falls by 10%$4.50$2057.00
Falls by 20%$4.00$4054.00

If the margin was lower than 5% the risk becomes even greater. In addition to any losses, this table doesn’t take into account any potential commissions, fees or interest the trader may need to pay.

  • CFDs are contracts

When trading CFDs, you’re buying a contract between you and the CFD provider. The contract outlines your speculations about the value of the financial product or underlying asset and is a legally binding agreement. Unless you have some trading knowledge and the time and patience to digest the provisions of the contract, you could get stung by a hidden clause.

  • The CFD provider may not act in your best interest

Not all CFD providers will act in the best interests of clients. This is referred to as counterparty risk. For example, there may be a delay between when you place a CFD order and when the provider executes it. This might mean your order is executed at a price which is worse, potentially costing you big dollars. If your trade is making a loss, your CFD provider could close out your trade at a loss without consulting you. The opposite is also true: you could implement a stop-loss order to try to protect yourself from losses, but the CFD provider may not honour this and might keep your trade open even longer. Because of these factors, the success of a CFD trade doesn’t just rely on your ability to make correct speculations and assumptions on the value movements of assets, but it’s also dependant on the CFD provider you use.

  • Your money might be held with other traders’ money

Every CFD provider has their own terms and conditions, but your money is generally covered by the law against a CFD provider misusing your funds. Some CFD providers may pool your money into one account mixed with money from other investors. They are then permitted by law to withdraw some of this money in the form of an initial margin and also a further margin if they need to. If your CFD provider withdraws this money it's no longer protected by the law as it's no longer in a client account and therefore counted as client money. If your money is pooled with other investors there’s an additional risk if one client fails to pay the money they owe in the event they lose a trade. This could delay your payments as the pooled account will be in deficit.

  • CFDs can be affected by market conditions

Because you’re speculating on the price movements of financial assets, such as shares, your trade will be affected by broader market conditions. However, because CFDs are highly leveraged, even a tiny dip in the market can result in not-so-tiny losses. Trading CFDs could become even more risky if you’re trading during times of economic uncertainty, such as major political elections. However even if the market is stable, there are often unpredictable, seemingly random events that affect the price movements of various financial products, making it almost impossible to predict for even the most experienced traders.

  • CFDs can move quickly

This is called ‘gapping’ and refers to the idea that a CFD can move in price between, for example, $5.50 and $6.00 without stopping at any of the price points in between. Therefore, even if you’d planned to close a trade at $5.55, you might not get a choice. Because the prices move so quickly, this opens up traders to increased risk.

How to mitigate these risks when trading CFDs

CFDs are a high-risk strategy and this is reflected in the strong warnings regulatory bodies such as ASIC place on them. Most investment strategies have an element of risk, and it’s important to understand what they are and what you can do to mitigate these risks before you begin trading. Here’s some strategies to mitigate the risks of trading CFDs:

  • Do your research.

Like any investment, it’s important to do lots of research before you begin. The more you understand about the ins-and-outs of CFD trading and the risks involved, the better.

  • Select asset classes you have experience with.

It’s a good idea to trade CFDs with underlying assets you understand and have experience with. For example, if you have lots of experience with share trading and understand what factors affect share prices, you could consider trading shares CFDs to begin with.

  • Start small.

It can be tempting to go big when you first get started, but remember when trading with leverage if you have the potential to gain a lot, you also have the potential to lose a lot. Trading in small sizes to begin with is a good way to get comfortable trading with leverage. It also means that if your trade doesn’t go as planned, you’ll only lose a small amount.

  • Open a free demo account.

Before committing your own money to a trade, why not take advantage of one of the free demo accounts offered by a number of CFD brokers on the market? IG Markets, Saxo Capital Markets and Pepperstone (to name a few) all offer demo accounts that allow you to practice executing trades in a simulated environment, providing you with an opportunity to test strategies and learn the mechanics of trading without risking any of your own capital. They even provide you with a small stipend of virtual funds to practice with.

  • Use stops and limits.

Tools such as stop losses and limit orders are a great way to minimise your risk, as they effectively allow you to cap your losses at a certain amount. These tools are a good way to protect traders against sudden or unexpected market movements, and are offered by most CFD trading providers.

  • Understand what you can afford to lose.

As CFDs are highly leveraged products, you can lose a lot more than your initial capital used to place the trade. It’s important to understand how much money you can comfortably afford to lose, so in the event that your trade doesn’t go well, you’re not losing more than you can afford. If you have done plenty of research and have extensive trading experience, you can compare CFD providers in our table below. If you want to learn more about CFDs, read our guide: What are CFDs?

Compare CFD providers

Name Product Minimum Opening Deposit Minimum Opening Deposit Commission - ASX 200 Shares Available markets Platforms
Vantage FX CFD
$200
$200
$8 AUD or 0.08%
Forex, CFD shares, Indices, Cryptocurrencies, Commodities
MetaTrader 4
MetaTrader 5
TradingView
Disclaimer: CFD Service. Your capital is at risk.
Vantage FX has some of the lowest CFD trading fees in Australia, plus you can place trades and find global trends through the new TradingView charts platform.
eToro CFD
US$200
US$200
No commission
Forex, Shares, Indices, Cryptocurrencies, Commodities, ETFs
eToro Trading Platform
Note: This broker offers CFDs which are volatile investment products and most clients lose money trading CFDs with this provider.
Join the largest social trading network in the world.
Plus500 CFD
$200
$200
No commission
CFD on Forex, Commodities, Cryptocurrency, Indices, Shares, Options and ETF's
Plus500 Trading Platform
Disclaimer: CFD Service. Your capital is at risk.
Trade CFDs on Australian and International shares, indices, cryptocurrencies, commodities and more.
IG CFD broker
$0
$0
0.08% with $7 minimum
Indices, FX, Shares, Commodities, Cryptocurrency, ETPs, Options, Interest Rates, Bonds
MetaTrader 4
ProReal Time
IG Trading Platform and Apps
L2
Disclaimer: CFD Service. Your capital is at risk.
Trade from over 15,000 markets with Australia's leading service for CFD trading and forex.
IC Markets CFD (True ECN Account)
US$200
US$200
0.1% per side
ASX shares, global shares, indices, commodities, forex, cryptocurrencies
MetaTrader 4
MetaTrader 5
cTrader
Disclaimer: CFD Service. Your capital is at risk.
Trade 230+ different products with fast execution under 40 milliseconds on average.
Saxo Capital Markets CFD
3,000
3,000
0.10% with $6 minimum
Indices, FX, Shares & ETFs, Commodities, Cryptocurrencies, Options, Bonds
SaxoTraderGO
SaxoTraderPRO
Disclaimer: CFD Service. Your capital is at risk.
Award-winning trading platfrom with extensive charting tools and reliable execution.
Blueberry Markets CFD Trading
US$100
US$100
$20 per month subscription plus 2% of trade size
Indices, ASX200 Shares, Commodities, Cryptocurrency
MetaTrader 5
Disclaimer: CFD Service. Your capital is at risk.
Bottom of the market fees on forex, CFDs and commodities with 24/7 quality customer service.
CMC Markets
$0
$0
0.09% with a $7 minimum
Forex, Indices, Commodities, Cryptocurrencies, Global shares, ASX shares, Bonds
CMC Next Generation CFD, MetaTrader 4
Disclaimer: CFD Service. Your capital is at risk.
Share CFD and forex ideas with other traders and take your strategy to the next level with over 100 technical indicators and charts on CMC’s mobile-friendly Next Generation platform.
Pepperstone CFD
$200
$200
No commission
ASX shares, global shares, indices, cryptocurrencies, commodities
MetaTrader 4
MetaTrader 5
cTrader
Disclaimer: CFD Service. Your capital is at risk.
Trade stock indices on the global market, via Pepperstone's MetaTrader 4 and cTrader client terminals.
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Compare up to 4 providers

Trading CFDs and forex on leverage is high-risk and you could lose more than your initial investment. It may not be suitable for every investor. Refer to the provider’s PDS and consider the risks before trading.

Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.

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