RISK OF CFD TRADING
While CFDs offer market participants a lot of benefits, it does not come without risks for holding the security. The access to margin trading (leverage) is something that is not suitable for all type of trader and investors.
Lack of Ownership
As the trader does not own the underlying product that he is trading, say, for instance, a share, then he does not possess the right to vote at a shareholders’ meeting. However, he will receive any dividend paid by the underlying company, and he has to pay the dividend if he is short of the CFD.
Cost of Overnight Financing
As CFD trading is done on margin, the trader is effectively borrowing money from their broker to trade, and for this service, the trader needs to pay an interest rate to the broker. This means that holding a CFD position for a long time could dent any returns made on the price change of the CFD.
- In case of clients holding a long position on the ex-dividend date, they are entitled to receive a cash-adjustment form of dividend
- In case of clients holding a short position on the ex-dividend date, they are chargeable for a cash-adjustment form of dividend
Another risk of trading in CFDs is the counterparty risk, a very familiar concept in most of the over-the-counter (OTC) traded derivatives. It is defined as the risk associated with the counterparty’s financial stability. Regarding CFD contracts, if the counterparty, e.g., your broker, is not able to meet the required financial obligations set by the trade, then there is no value associated with the CFD, regardless of the underlying instrument. In other words, if you bought Apple Shares at 50 dollars a share and two years later the share price is at $250, and your broker goes bankrupt before you book profits and withdraw your money then you could have lost your profit.
However, CFD providers over the OTC desks are required to segregate the client funds to protect client balances in the event of a company default. However, cases such as that of MF Global remind us that guarantees can also be broken.