Many people enjoy trading shares and commodities such as oil, gold and silver. Some retail brokers offer share CFDs (contracts for difference), enabling traders to buy or sell stock in increments of 1 cent per point without holding the underlying security.
For this reason, some people are tempted into CFD trading when they want to speculate on specific market movements without taking the more significant risk that comes when buying actual stocks. However, you should know that there are no specific laws in Australia that layout restrictions against CFDs; they are not covered in ASIC’s Corporations Act 2001 or its Financial Services Reform Act 2001.
They fall under the auspices of general consumer protection legislation through fair dealing practices – laws designed to protect Australians from unfair business practices in the financial sector.
Ultimately, CFDs are a speculative instrument, and they come with several risks. They can be addictive because traders can make a profit quickly, but there is no guarantee that any particular trade will be profitable. Meaning it’s both important to understand the risks involved before trading and ensure that you choose a regulated broker before starting. It may even be worth considering talking to someone who knows what they’re talking about before you start trading CFDs.
What are the risks of CFD trading?
Leverage can work against you
The leverage levels used by CFD providers enable traders to make large profits quickly. However, this amplifies gains and losses because of margin rates, but it can also lead traders into dangerous territory when they’re taking risks on thinly traded securities. With little market depth, it’s hard for investors to find buyers or sellers should they wish to move their positions. For example, let’s say you think the price of gold will drop in the next hour. You borrow $25,000 worth of gold via your CFD provider and sell it at market rate – so you’ve made $25,000 straight away. However, if people start buying up that gold before your time expires (or refuse to sell for what you’re asking), you could be left with a costly short position that’s difficult to close.
The key here is to research your broker thoroughly before signing up; make sure they’ve solid financial backing and are regulated by ASIC or another body like the FCA.
CFDs are risky speculations
It would be best to understand that Australia CFD trading is highly speculative. It’s effortless to make a bad investment with CFDs, and even if you do your research, it’s still possible to lose all of your money. As such, they should only be traded by experienced investors who have a thorough understanding of the risks involved – or at least people who are prepared to learn from their mistakes.
Fraudulent brokers exist
As is common in the financial world, there is a small risk that some CFD providers will try and involve themselves in fraudulent activities. These include churning (where an advisor encourages his clients to enter into trades that he then makes a profit from), placing excessive commissions on transactions without disclosing them as such and using bait-and-switch techniques where traders open an account. Still, the brokerage fails to provide the promised trading conditions.
As a result, it’s imperative to check that ASIC or another respected authority regulates your broker before you start trading with them. Even if they are authorised, it’s worth looking for reviews from other traders so you can get a better understanding of how creditable they are.
CFDs can be addictive
Trading CFDs can feel like a cash cow because it’s easy to make cash quickly, especially if you’re using leverage. However, this makes them dangerous and can lead to risky and even reckless trading. You could end up with substantial losses that the broker won’t allow you to withdraw from your account or result in plummeting credit ratings as you max out your cards to meet margin calls.
High costs of CFD brokers
Since no specific laws govern their conduct (as there are for traditional transactions), CFD brokers may charge high fees for their services – especially those brokers which offer leverage ratios above 100:1. Although they might not technically be breaking any rules, these inflated fees might still be considered a form of market manipulation. In some cases, brokers may not fully disclose the extent to which they charge for their services on their websites or in promotional material.
