Is CFD Trading Safe?

Is CFD Trading Safe?

Trader holding a safe in his hand in front of a background chart and digital screen

No matter how you heard about CFDs in the first place, if you’ve made it this far, you know one thing: the returns from successfully trading CFDs can be huge.

But what about the risks?

Unfortunately, there’s no clear cut answer as to whether CFD trading is safe. Instead, the best that can be said is that it can be safe, and it can be very, very risky. At the end of the day, the determining factor will be how you personally manage your risk and your emotions when trading.

Here are some of the factors that affect the safety of CFD trading, and how you can manage them to stay safe in the markets.

Risk #1: Market Volatility

Market volatility is a double-edged sword. Volatility, the variation in a financial instrument’s price, is both what gives a trade its upside and downside — if there were no volatility in the markets, the price would always stay the same, and there would be no money to be made or lost.

Some markets are generally more volatile than others, which means that the wins are bigger, but so are the losses. For example, the cryptocurrency markets experience huge swings daily, while blue chip stocks are generally a lot more stable.

Market volatility can also vary based on the time of day or whether there’s a special event occurring. For example, the first hour of the NYSE from 9:30 am to 10:30 am EST is the most volatile part of the day, and markets are famously volatile around news releases, such as earnings reports, unemployment statistics, etc.

Risk #2: Leverage

When you trade with leverage, it means that you borrow shares or contracts from someone else, trade with them, and keep the gains or losses for yourself. This allows you to trade with more money than you currently have.

For example, if you make a $1,000 trade using 100:1 leverage, you will essentially be trading with $100,000. That means that you can buy more contracts — if a single contract costs $10, you could buy 100 without leverage or 10,000 with leverage. If you entered a long position and the price per contract goes up $1, you would make $100 without leverage, or $10,000 with leverage.

However, if you lose, you can lose a lot. Luckily, TradeDirect365 offers negative balance protection, but with other brokers, you could end up owing $9,000 if the price per contract went down $1.

Essentially, leverage makes it very easy to take your account to the moon or blow it entirely in just a few trades — or even just a single one.

Risk #3: Emotions

No matter what instruments you’re trading, your emotions will always come with you. Although this is often overlooked, many traders attest that emotional control is the most important part of being a successful trader.

If you’re not in control of your emotions, you can easily end up “revenge trading” to make up for a recent loss, holding on to a losing trade too long instead of cutting your losses, or becoming overconfident after a string of wins and entering an overly risky trade.

The Solutions: Money and Emotional Management

When you trade, your goal is to skillfully ride the market’s waves. You want to correctly read the market to determine which way it’s moving, to enter a trade in that direction, and to exit with a win.

But winning all the time is simply not possible — you can only hope to win a majority of the time. Losses are an important part of trading, and they are unavoidable.

The secret to successful trading is learning how to manage your losses. While this is not a simple topic by any means, the core of the idea is that you need to ensure you’re:

  1. Only risking a small amount of your account on any single trade (typically between 0.5-2% of your account)
  2. Not trading when you’re in an emotional state of mind (aka tilted)

If you follow these two rules, you will increase the safety of your CFD trades, even though you can’t eliminate the risks entirely. Think of it this way: if you have a $100 account and stick to a maximum of $2 risk per trade (in practice the dollar risk would decrease over time, but we’ll leave it static for simplicity’s sake), you’d have to lose 50 times in a row to deplete your account.

But if you risk $50 per trade, you only need to lose twice before you’ve blown your account. Considering that even the best strategies may only win less than 50% of the time, this is a surefire way to lose your money.

So, is CFD trading safe? There are a lot of risks, but it’s possible to manage them through skill and practice.