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Why It's Important To Be Careful Trading CFDs

When it comes to successful trading, caution is a necessary virtue for the preservation of capital, and in ensuring you take decisions in the best interests of your wider portfolio. Having discussed the disadvantages of leverage and the potentially disastrous effect of calling it wrong when trading margined products, it's important to stress the value of caution in adopting leveraged positions, to ensure the levels of risk involved are given sufficient consideration and weight before it's too late.

Leverage plays an inherent role in the appeal of CFD trading, and it is a central component to the idea of trading contracts for difference. Because CFDs are traded on margins, traders find themselves embracing leverage as a part of their CFD trading, and should ensure that their exposure is kept within reasonable boundaries at all times to avoid bearing the brunt of leveraged losses. As a result, CFD traders in particular need to take steps to hedge their positions, and set controlled stop losses to prevent undue liability for unfavourable positions.

Unfortunately, there are countless traders of all levels of experience and success that have lost out as a result of careless or risk-averse trading on margined, highly leveraged products. Indeed, much of the last global banking crisis could be attributed to poor risk management, and to avoid a similar fate in your personal trading its important to take care in the positions you open and the level of risk and leverage you're prepared to take on board.

Make sure you understand the impact of any leverage on a particular trade before you commit to opening your position. Calculate your potential losses (including any stops you may have in place), and add these to the costs of entering the position - is it feasible that you will be able to recoup these costs, or are you hoping for significant market movements to cover these expenses?

Furthermore, CFD traders can often run into difficulties by failing to take account of the larger costs associated with leveraged transactions. Firstly, transaction commissions are usually payable on the total transaction amount - i.e. not just the margin requirement for a particular trade. This translates into transaction costs that are relatively high compared with pound-for-pound trading.

In addition to the broker commissions, your leverage will give rise to an interest charge, to be paid from any profits your position ultimately takes. Interest is obviously payable relative to the duration of the leveraged position, with longer-term overnight positions attracting higher interest costs than shorter-term trades. As part of the overall package of costs that go hand in hand with leverage, interest is an important factor to include in any individual profit calculation, to make sure the position you've taken is one that could logically yield a satisfactory profit.

Leverage and CFD trading go hand in hand, and it's important not to be too scared of applying leverage to your transactions as and when necessary. However, being sure of the risks and the potential pitfalls associated with a leveraged trade goes someway to ensuring that your trading is kept within manageable boundaries, and that you're prepared to meet your obligations in respect of any losses and margin calls that may be forthcoming in the aftermath of a rogue trade.

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