This setup enables individuals with a relatively small initial investment to incur lucrative gains — those that are equivalent to that of the underlying market or asset. And even though on paper CFDs seem like an investment no-brainer, the unfortunate reality is that the ‘margin trade opportunities’ afforded by these tools can magnify not only one’s profits but also losses quite exponentially.
A Breakdown of the Risks Involved
Here are some of the core drawbacks associated with CFD trading include.
Counterparty Issues
From the outside looking in, a ‘counterparty’ is a firm that provides users with assets to successfully facilitate a CFD trade. However, when dealing with the buying/selling of CFDs, the only asset is traded in the contract issued by the CFD provider. Due to this arrangement, traders are directly exposed to the financial risks of various counterparties, including other companies that the CFD provider may be dealing with on a regular basis. Not only that but there are also further legal implications to consider if a counterparty fails to fulfill its financial obligations.
In closing, investors need to understand that the CFD market is still largely unregulated and is governed largely by the reputation of various brokers — based on certain elements such as their past credibility, market longevity, etc.
Imminent Market Risks
As highlighted previously, CFDs are basically derivative assets that a trader can make use of to speculate on an underlying asset’s day-to-day market movements. While this does open up a possibility of solid short-term gains, there is also a chance that the market can move in the opposite direction.
In this regard, any unexpected changes — such as a change in govt regulation, or market swings — can have an overnight effect on one’s CFD returns. To be a bit more specific, a slide in the value of one’s underlying asset can result in the provider asking for a second margin payment. Not only that, in certain cases, the provider can even go ahead and close one’s position.
Client Money and Liquidity Related Risks
Across regions where CFDs are legal, providers are required to segregate their client’s funds from their own so as to prevent them from hedging their own investments. That being said, in some counties there exist laws that do not prohibit clients’ money from being accumulated across a number of different accounts.
Not only that, but due to the volatile nature of the market, liquidity risks are also quite prominent in relation to CFDs. For example, if there are not an adequate number of trades taking place in the market, there is a possibility of a contract becoming “illiquid”. In such a scenario, CFD issuers can charge a larger margin payment or even choose to conclude a contract at an inferior price.
CFDs and Crypto
Quite simply put, cryptocurrency CFDs are extremely high-risk, speculative investment instruments that come with a range of issues related to price volatility, and leverage that can cause users to incur massive losses. In this regard, it should be highlighted that the digital asset market is regularly faced with daily volatility of up to 10%, something that can cause investors to suffer massive losses. Not only that, some firms offer insane leverage of up to 50x, which may look appealing at first but when considering the financial liabilities involved, should be a major source of concern for anyone looking to invest in crypto CFDs.
