Risk management plays an important part in trading success and is fundamental to any strategy.
CFDs are leveraged products traded on margin. The initial margin required to take a CFD position represents only a small percentage of the total value of the contract being controlled. The risk of a gain or loss trading in leveraged products can be amplified with a relatively small market movement in the underlying having a proportionately larger impact on the funds that a client has deposited or will be required to deposit to maintain their position. If the clients CFD position deteriorates or if margin levels are increased the customer may be called upon at short notice to pay additional funds in order to maintain the CFD position. It is important to note that trading in leveraged products may result in losses greater than the initial deposit required to open a CFD position.
CFDs are an over-the-counter (OTC) leveraged product traded on an off-exchange basis. Off-exchange transactions are typically less regulated and are subjected to a separate regulatory regime. The firm with which customers conduct their transactions (which may be PhillipCapital, if PhillipCapital acts as your broker to effect a transaction with such firm, or another firm) may be acting as a counterparty to the transaction.
Counterparty risk arises when the CFD provider fails to meet a due payment obligation under a CFD. For example, if a holder of a long CFD contract has made a profit and is supposed to receive this gain from the CFD provider. A holder of a long CFD contract should note that he has no recourse to the underlying shares as he has not actually bought the underlying shares.
As CFDs are traded on an OTC basis, they are subject to the availability of buy and sell prices and volume. Some CFDs have lower liquidity than others, which makes them more difficult to trade at the market price. When this happens, the CFD may not be sold within a reasonable time (if at all) or may be traded at a price which may not reflect its “fair” value. For example, the customer may be required to lower his/ her asking price to sell the CFD, which may incur losses as a result.
Order Type Risk
When trading CFDs, customers can place certain orders (e.g. stop-limit orders). While these orders could limit losses to certain amounts in most instances, it may not be effective when market conditions make it difficult or impossible to execute such orders without incurring substantial losses.
Further information about CFD risks can be found in our PDS and ASIC CFD Trading Guide.