Examples of CFD Trading
Trading contracts for difference is a risky business by its very nature. The high returns that are up for grabs can only really come about with a corresponding high-risk profile, and for traders that dare to meddle with leverage, the penalties for getting it wrong can be harsh, swift and severe.
Aside from the risks of simple errors of judgement or ill fortune in trading CFDs, there are also a number of inherent risks in investing your capital which must be given due consideration. The successful trader should be able to recognize the diverse range of risks facing his portfolio, so that further risks can be minimised to reduce potential losses. But what do these risks look like, and what can they mean for your portfolio?
Market Risk
Every trader who has ever taken exposure in a market has faced market risk, and in many cases it has been a central contributing factor to the demise of successful traders. Market risk is the risk inherent in the market: that is, that the value of investing in the markets generally will fall, and investors will move their money into alternative markets. Over time, most traders assume that the markets will generally trend upwards. Market risk is the threat posed by markets drifting downwards, and is a factor that can externally act to depress the value of your trades and positions.
Liquidation Risk
For CFD traders in particular, the liquidation risk posed by exposure to the markets is significant and a constant factor to bear in mind throughout the duration of the trade. Liquidation risk is essentially the risk of a position or multiple positions across your account being liquidated at the demand of your broker in the event that you face a margin call for one or more of your trades.
A margin call is essentially a demand for a top-up to the margin requirement, which can come about as positions change in value. This risk of throttling profitable positions simply because of liquidity risk from other trades is one that requires careful financing planning to minimise. Know how much you've got invested, and know how much you're likely to need in cash as a buffer to support your positions as they develop - this is critical to your success.
Counterparty Risk
Counterparty risk is the risk that arises from dealing with a third party for trading purposes. In most cases, the counterparty risk to CFD transactions will stem from the broker, who is of course the counterparty to the trade. What this risk essentially entails is the risk that the broker will default or become insolvent or be otherwise unable to honour its obligations. Naturally, this risk is minimised by choosing a reputable broker, but it is nevertheless a risk to bear in mind, and many traders spread their trading capital over different brokers to avoid being too heavily exposed to the counterparty risk of any one provider.
These inherent risks are shared by all CFD traders, but that's not to say they should be overlooked. Understanding the threats to your trading capital is the first step in building in solid defences within your portfolio - critical for protecting your capital and weathering the storm for when markets inevitably periodically run against you.
