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Understanding the risks of CFD trading

What are CFDs?

CFDs (contracts for difference) are a type of derivative product that allows traders to speculate on the price movements of various assets, including stocks, commodities, and currencies.

When you trade CFDs, you don’t own the underlying asset but instead, enter into a contract with the broker to receive the difference in prices when you open and close your position. If you buy a CFD on Apple stock at $100 and go up to $110, you would earn $10 per share. However, if the stock falls to $90, you would lose $10 per share.

Why trade CFDs?

There are several reasons why people might choose to trade CFDs. First, CFDs offer leverage, which means that you can trade with a much smaller amount of capital than you would need to buy the underlying asset outright. For example, if Apple stock is trading at $100 and you want to buy 100 shares, you need $10,000. However, if you only have $1,000 to invest, you could use leverage to trade 10 CFDs on Apple stock. It allows you to control a much more prominent position with relatively small capital.

Another advantage of CFDs is that they allow you to short sell assets. It means that you can profit from falling prices as well as rising prices. For example, if you think Apple stock will fall in value, you could sell 10 CFDs at $100 and then repurchase them at a lower price to make a profit.

Despite the advantages of trading CFDs, some risks are also considered. The article will elaborate on them next. You can also take a look on https://www.home.saxo/en-sg/products/cfds for up to date information and articles about trading CFDs in Singapore.

Lose more money than you have invested

First, because CFDs are leveraged products, you can lose more money than you have invested. If you invest $1,000 in Apple stock and the price falls by 10%, you would lose $100. However, if you trade 10 CFDs on Apple stock with leverage of 10:1, a 10% price decline would result in a loss of $1,000. Therefore, it is crucial to use stop-loss orders to limit your losses.

No ownership of the underlying asset

Second, because you don’t own the underlying asset when you trade CFDs, you rely on the broker to honour your position. If the broker decides to close your position (for example, if they go bankrupt), you could lose all of your money.

Margin calls

Third, if the underlying asset’s price moves against you, you could be forced to make a margin call. It means that you would need to deposit more money into your account to cover your losses. If you can’t meet this demand, your broker could sell some or all of the assets in your account to cover the loss.

Liquidity and pricing risks

Fourth, CFDs are traded over the counter (OTC), which means no central exchange where prices are set. It can lead to liquidity and pricing risks, as the prices of CFDs may not reflect the underlying asset’s real-world price.

No protection from market crashes

Because CFDs are OTC products, they are not protected by government regulators in the event of a market crash. It means that you could lose all of your money if the market falls significantly.

Not suitable for all investors

Finally, CFDs are not suitable for all investors. They are complex products and can be risky if misused. It is essential to understand the risks involved before trading CFDs. CFDs, or contracts for difference, are a type of derivative product that allows traders to speculate on the price movements of various assets, including stocks, commodities, and currencies.

CFDs are a type of derivative product.

Derivatives are products that derive their value from an underlying asset. For example, a stock option is a derivative because its value is based on the underlying stock price. CFDs are a type of equity derivative, meaning that their value is based on the price of underlying equity (in this case, the stock)

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