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August 23, 2020

CFD Risks And Tips to Minimize Them

If you are looking for a fast and easy way of making money in the financial market, CFDs are a great alternative. These derivatives provide a wide variety of diversification opportunities, offer an easy way for people with limited capital to make massive profits, attract lower trading fees, and have very few restrictions. This, in addition to the fact that you can use advanced feature-rich tools, like those available to users of MT4 (MetaTrader 4), makes them the perfect investment vehicle for both beginners and advanced traders.

However, this does not mean that CFDs offer risk-free money-making opportunities. While they provide a great way to both diversify and make a killing in the market, these financial instruments come with risks that you should definitely be aware of.

CFD Risks

Trading in CFDs is attractive because it does not feature a lot of restrictions. Unfortunately, this creates an element of risk. Since CFDs are not as regulated as other financial instruments, there is always a risk of you losing your money.

Essentially, a CFD contract is a contract between you and your broker. When you make bets on the direction you think the price of the underlying asset will go, you are essentially entering into a contract with the broker. If you exit your position at a price that is higher than the price at which you entered, it is your broker who will pay you the profit.

As a result, a lot depends on your broker. If they go bankrupt, or if they are untrustworthy, then you risk losing your money even when you are making winning trades. It is because of this reason that beginners are always advised to chooser established brokers who have a good reputation that has stood the test of time.

The other risk that comes with trading CFDs relates to margin trading. Since you use margins to get into CFD contracts, you stand to make a lot of money. Unfortunately, this feature can leave you overexposed. Margin trading can blow up your overall trading risk to such an extent if the market goes against you, you can end up incurring losses that exceed your deposit. This is sometimes enough to derail an investor's journey to success especially if they are beginners since they are the ones who are likely to lose sight of extent of the risk that margin trading exposes them to.

How to Minimize CFD Risks

In order to protect yourself from the potential risk of margin trading, it is important to come up with a good trading strategy way before you start executing trades. Thereafter, when trading, stick to this strategy, no matter the temptation to make more money. Keeping a clear and concise record of the total exposure on CFDs will also help to ensure that you keep a close eye on the performance of your trades.

The other thing that you can do to keep your exposure to a minimum is to take full advantage of stop orders. Place these orders on every trade you make so that in case the market starts moving against your position, the orders will be triggered. This will then automatically get you out of losing positions, something that will definitely go a long way towards limiting your losses.

Since stops are automatic, they also help to keep you from indulging in your emotions. They can save you from executing emotional trades and therefore help you from making mistakes that most beginners make.

Keeping a comprehensive trading journal will also help you in keeping CFD risks under control. With a good journal, you should be able to record all the positions you entered into, reasons why you entered into them, and then your exiting strategy. Reviewing your activity should be enough to give you a clear picture of your overall risk profile.

While the benefits outweigh the shortcomings of CFDs, it is always good to be aware of these risks before assuming any position in the market. Doing so will prevent catastrophic losses.

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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