Contract For Differences (CFD) – Chapter 3: The risks of investing in CFD’s



Contract For Differences (CFD) – Chapter 3:
 The risks of investing in CFD’s

The very fact the you can leverage your trading in CFDs with a margin account means that you are able to increase your profitability level. However, it also means that your exposure to losses is also multiplied several times over. Technically, the potential losses that an investor may face are unlimited.
CFDs are not suitable for long term investments as the holding cost will be greater than that if you had brought the under lying asset itself.
Because you are utilizing the margin facility of your brokerage firm, you are subjected to margin calls if the market moves against you.
When an investor trades on margin, his cost actually increases as he is liable for interest that is payable on the leveraged amount that he utilizes. Any overnight market position is liable for this interest. It is for this reason that CFDs are suitable only for short term market position.
CFDs might not necessarily be suitable for all classes of investors. As mentioned earlier, CFDs are entitled to the dividend yield of their underlying assets. This however does not mean that CFDs’ investors are entitled to the voting rights of the underlying assets. This is because the legal title to the underlying assets does not pass to the investors with the purchase of the CFDs. Thus, if an investor is more interested in the shareholder rights of a company, it would be a better move for him to purchase the actual stocks of the company.
The Guaranteed Stop Loss mechanism used to help an investor limit his losses does not work perpetually as they have an expiration date. They are also usually expensive. Thus, you also have to keep in mind the amount that is spent on the Guaranteed Stop Loss and its expiry date to ensure that they are cost effective.
Although you are entitled to dividend yields, you are also liable for the dividend paid out if you short your market position. This is because the dividends are also taken into consideration when you calculate the actual value of the CFDs. You will not face the same circumstances had you actually purchased the underlying assets of the CFDs.
You need to use a “Limited Risk Account” if you really wanted to limit the extent of your liability to the amount which is deposited in your trading account.

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