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Downsides of Using CFDs to Day Trade

CFD Trading Risks
Written by Andy

We know contracts for difference are useful instruments to trade but what are the weaknesses of CFDs? Although there are many advantages to using CFDs in your day trading strategy, there are also some downsides and it is crucial that anybody who trades derivatives understands that there are some weaknesses with CFDs. These are listed below -:

  1. Time: Since all of your trading will happen during market hours over short time frames, you need to monitor your trading screen constantly, and this process can be time consuming.
  2. Decision making: As timing is crucial in day trading, it is important to have a good idea about your trading system/strategy as you will have to make quick decisions about your trades.
  3. Capital outlay: Day traders often focus on profiting from smaller price movements, which means that in order to make a large amount of money it is necessary to start off with a bigger float or use more leverage.
  4. Margin requirement: As CFDs are a highly leveraged financial product, a small movement in the price can have a large effect on your account. If the price starts in the wrong direction and you have staked a large amount of money or used more leverage, you may find that you suffer a margin call to put more money in the account. If not answered swiftly, this may even lead to an automatic closing of your losing position.
  5. Market maker: If trading with a market maker, there is the risk that prices achieved do not fully reflect the market. The market maker will often be in a counter position to you, and it is not in his interest to give you the best prices. Some CFD providers profess to offer DMA access when they are in effect delivering a hybrid product. We constantly highlight the differences between Direct market access and market makers.
  6. Exchange traded CFDs: Where available, exchange traded CFDs provide consistent pricing, but have a problem in that they take more in charges to pay for the exchange and clearing house operations in addition to the broker.
  7. Overtrading: As with most day trading markets, there are times when not much is happening and there are no worthy trades. Boredom quickly leads to overtrading, taking positions that are only marginal in order to be doing something.
  8. Unfamiliar securities: As CFDs are available on so many different financial securities, another way that some traders try to overcome quiet periods and boredom is to look for a market that is moving at the time. This can lead to trading with unfamiliar securities that you have not learned to anticipate properly.
  9. Leverage: Although the leverage available with CFDs can be a means to higher profits, it is especially dangerous in the context of day trading where decisions must be made quickly. The gearing provided by CFDs can rapidly punish an unwise hasty decision.
  10. Staying in the game: Even when you have made a good choice of trade, the highly leveraged CFD may have an initial false start in the wrong direction. Because of the leverage you may be unable to respond to the funds required long enough to stay in the trade and enjoy the subsequent profit.

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