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When it comes to online trading, one of the most popular instruments is CFDs or Contracts for Difference. CFDs are a type of derivative product that allows traders to speculate on the price movements of underlying assets without actually owning the asset itself. This makes them a highly versatile and popular tool for many traders.
What Are the Main Risks Associated With CFD Trading?
1. Counterparty risk
Counterparty risk is one of the most significant risks when trading CFDs. This is the risk that your broker or the other party in your trade will not be able to meet their obligations. This could lead to a loss of your funds.
One way to reduce this risk is to only trade with brokers authorised and regulated by ASIC, the Australian Securities and Investments Commission. ASIC is Australia’s financial regulator, and it has a strict regulatory regime for brokers offering CFD trading.
2. Market risk
Another key risk when trading CFDs is market risk. The risk is that the market will move against you, leading to losses on your trades.
It is important to remember that CFDs are leveraged products and therefore can amplify losses and profits. As a result, you should only trade with money you can afford to lose.
3. Liquidity risk
One other key risk when trading CFDs is liquidity risk. This is the risk that you will not be able to close out your position at the price you want due to a lack of liquidity in the market.
This can often happen in times of market volatility when there are more sellers than buyers in the market, and it can also happen if you try to trade a substantial position. To reduce this risk, it is essential to trade with a well-capitalised broker with a good reputation.
4. Margin call risk
Another critical risk when trading CFDs is margin call risk. This is the risk that your broker will require you to deposit additional funds (on top of your initial margin) to maintain your trade, or they may close out your position if the margin falls below a certain level.
This can lead to significant losses if you are unaware of the margin call risk and do not have the additional funds to cover it.
How to Mitigate the Risks Involved in CFD Trading?
CFD trading can be a very profitable venture if done correctly despite this risk. How can you mitigate the risks involved in CFD trading and maximise your chances of success? Here are a few tips:
- Always do your research before making investment decision. It’s essential to understand the underlying asset that you’re trading and the risks involved.
- Start small and don’t invest more than you can afford to lose. This will help to minimise your losses if things go wrong.
- Use a reputable broker. Make sure the broker you use is regulated and has a good reputation.
- Stay disciplined. Don’t get caught up in the excitement of trading, and make sure you stick to your trading business plan.
- Have a plan B. In case things go wrong, it’s essential to have a backup plan in place to avoid losing too much money.
So, these are some of the key risks associated with CFD trading in Australia. It is essential to be aware of these risks before you start trading and only trade with money you can afford to lose. New traders and investors are advised to use an experienced and reliable online broker from Saxo Bank and trade on a demo account before starting their investment journey.