CFD has become one of the most popular trading derivatives worldwide, especially in forex trading. Investors nowadays are making a beeline for its profitability. Attracting by its high leverage, new traders have yet shrunk back in fear for its potential risk.
Under the regulation of the European Securities and Markets Authority (ESMA), CFDs brokers are required to disclose their profit/loss ratio of their clients’ trades. According to a survey in 2018, data shows that there are 76% of traders experienced losses whilst only 24% won profits.
What’s going on behind such a scenario? Indeed, the unpredictable market risk is one of the factors. But beyond that, some traders have no idea of the contract amount of their trading assets or even misunderstand the price moves. That’s the reason why things do not go as well as expected when traders have mixed up the concepts.
ZFX, therefore, wishes to dissect the risks for you and draw up a management plan that fits your needs, providing you proper risk measurement on your trades.
Risk 1: Over-leverage
Trade with leverage is one of the key features of CFD trading. With its high leverage possibility, investors are able to maximize their profits through trading with margin.
CFD trading allows you to earn a decent profit even in small volatility of price movements while you are only required to pay only a little amount of margin to open a position. Generally, you have to pay 1%-5% of the position’s gross value, or even less. The ratio of the position’s value to the margin is called the ‘leverage ratio’ or ‘gearing ratio’.
Example of leverage trading
How does leveraged trading amplify your profit/loss? Here is an example:
When you invest $1,000 for a company’s shares with its market price of $1,000, you are trading without leverage. If the stock price goes up by $200, you are making a profit of $200, which is 20% of your capital. If the price has yet moved the opposite way, you would then suffer from a $200 loss.
On the other hand, if you open a position with a $100 margin for the shares at $1,000 market price, you are trading with a 10:1 leverage ratio. With the leverage effect, you would make a $100 profit, which is 100% gain of your capital, even if the stock price goes up by just $100. Oppositely, you will suffer from a total loss of your capital when the price goes down by $100. (A margin call would occur whenever the margin is not sufficient to offset a certain level of loss.)
It’s therefore important to have a thorough understanding of the products you‘ve chosen and never over-estimate your risk-taking capacity.
Risk 2: Brokers/ trading platforms with no regulation
Nowadays, there are all kinds of financial brokers claim that they are offering the services of CFDs. Once you’ve chosen a poor one, you may have to face the unexpected additional risks, such as capital insecurity, misquotation, and illiquidity. An illegal intermediary who conducts swindle business but with scenic packaging is particularly common in the PRC.
In this way, putting emphasis on trading security has become one of the most essential objective prerequisites when selecting a good broker. In that context, what a smart investor is to make sure the chosen broker is holding the most trustworthy license.
The following are the four largest authoritative institutions running the best and most stringent regulations for CFD brokers across the world.
- U.K. Financial Conduct Authority (FCA)
- Australian Securities and Investments Commission (ASIC)
- U.S. Commodity Futures Trading Commission (CFTC) (Only available to the U.S. domestic traders)
- EU Financial Instruments Market Management (MiFID)
Apart from offering licenses to brokers, some institutions even possess powers in law enforcement. For example, FCA is one of the authorities with the power to withdraw mandates from its non-compliance members. What’s more, FCA could ask for shutdown to the non-compliance websites by executing its power over the networking provider.
ZFX is one of the most regular parties precisely under the strict supervision of the FCA, in terms of risk management, cooperate financial security, financial crime prevention, as well as advertising compliance. You can speculate an enrichment opportunity at ease simply with the trading services offered by ZFX.
Last but not least, please be reminded that leveraged trading is no double a perfect instrument that speeds up profitability. Indeed, you will yield twice the result with half the effort. However, the gearing effect would work both ways. You could recognize the market and seize the opportunity only when you have well managed the risks.
Risk Warning: The above content is for reference only and does not represent ZFX’s position. ZFX does not assume any form of loss caused by any trading operations conducted in accordance with this article. Please be firm in your thinking and do the corresponding risk control.
ZFX (Zeal Capital Market) is an online forex & CFD broker providing more than 100 products for forex trading, commodity trading, index trading, and share CFDs trading. The minimum deposit for the account opening is only USD 15. Open a trading account and download our MT4 trading platform now!