CFDs: The Adventures and Pitfalls of Leveraged Products
CFDs, or Contracts for Difference, make investing in more expensive markets easier for small investors. CFDs are a leveraged product, which means that investors need only deposit a small amount of the trade’s overall value. Returns and losses on these investments will be magnified, which means that a CFD is a risky but potentially lucrative product for experienced investors.
Pros of CFDs
There are some huge advantages to using leveraged products, available through a CFD trading provider, if done correctly. Leverage is an efficient use of capital when used by professionals. Traders who use leverage can trade in products that they would be unable to trade in otherwise. It also means that traders can utilize capital which they don’t have in cash, meaning that traders can trade more contracts than they would be able to without leverage. This can vastly increase a trader’s end return.
Of course, the magnified returns are also a big attraction for many investors. Depending on the size of the margin on an investment, returns can be significant. In some investments it is possible to enjoy returns of 6-7 times the change in share price, meaning that it is possible to make very big returns on small amounts of money.
Cons of CFDs
However, losses on CFDs are also magnified in the same way as returns, and you can potentially lose all or part of your deposit. If share prices drop after you have made an investment, your net loss can even be more than the amount which you initially deposited. This is why it’s important that CFDs are managed by experienced investors who are prepared to take risks; CFDs and other leveraged products are not risk-free investments.
Leveraged products can also sometimes be untenable for some investors. Many leveraged positions are long-term, and the high costs of holding these positions can often make bigger returns much less worthwhile when compared to the risks involved. The longer leveraged positions are open, the more costs an investor usually accrues, and the less tenable these products become. Leveraged products, including Contracts for Difference, are best used as part of a larger portfolio to reduce potential risks; if money is lost on leveraged products, it can be made back in other ways. While some investors may be put off by leveraged products by the magnified risks involved, the magnified returns often make these products well worth the risk when used sensibly and in moderation by experienced investors.