Contracts For Differences are an extremely popular way for people to trade the financial markets. One reason for their popularity is that they are traded on margin and although this feature is something that can help traders make huge profits it also adds significantly to the risk factor.
What is margin?
Whenever you buy a Contract For Difference you will do so with leverage and you will only be required to deposit the minimum margin required to hold a position. The required margin level will vary depending on the broker and the perceived risk of the market but in some cases this will be just 1% of the total contract value.
An easy way to understand the concept is to relate it to a purchase of £100,000 BP Shares where you are only required to put down a deposit of £1000 to take ownership.
Using this example we can see where the risk of CFDs comes from. If you weren’t trading on margin, the most you could lose is £1000 (if the company failed). If on the other hand the company ceased trading and you had bought a CFD with your £1000, it would be possible for you to lose £100,000. This example is an extreme one but it does highlight the main risk involved with Contracts For Differences well.