Friday, May 30, 2008

The Biggest Risk When Making Money Trading CFDs

Contracts For Difference or CFDs, as they are known, have allowed many small investors to participate in the the markets at levels previously reserved for the bigger players. However, CFD providers are not brokers and this presents a problem that does not exist on the open market.

CFD providers can be compared with bookmakers who bet on the probabilities of a horse winning or losing or coming the place, or being placed in some other combination as the first or second place-getters or first three or four place-getters, or even first two or three or four place-getters in exact order that they finish. Unlike CFD providers, around the world, bookmakers are becoming a dying breed and pari-mutuel betting on a totalizator pool is more common, and in a way acts like an open market, where no one is pitted against a particular operator who sets a market and becomes a market maker.

Actually, CFD providers are like the bucket shops that used to operate in the early days of the stockmarket, where the operators would run a virtual market that approximated the stockmarket. The idea was a market would be created simulating the real market, and the operators would work on punters trading with them, and they would lay the money on the real market or back their judgment and take on the punter who would trade against them.

Jesse Livermore, the renown trader of yesteryear, learned how to trade the markets in the bucket shops, and was one of the few people to make a living from them, even though the odds to do so were greater than playing the open market.

If you can make money against a bucket shop CFD provider, you will certainly be able to do so on the open market. The difference between the CFD provider and using a broker on the open market, of course, is you can leverage your money with minimal cost using CFDs. There is no having to set up a line of credit with a banker or a financier, you just simply apply via an application form and once your account is set up, you are off and trading. All you need is the minimum amount that is required to open an account. In many instances, this is as low as one thousand dollars.

The biggest risk faced by people buying CFDs is if the market falls unexpectedly. This can happen when disasters occur, like planes being flown into the New York Twin Towers, or the London Bombings, or any other terrorist activity. This can also happen if their is some unexpected bad financial news like a major company going bust or a run on a bank or unexpected high unemployment figures or news of war. Any news that is construed as having the possibility of being disastrous will see the stock market fall very fast, and if you happen to have CFDs, there is a strong probability that your account could be wiped out.

There are two reasons why you could be wiped out. One is you are not keeping an eye on your investments when the event occurs. The second reason is you are keeping an eye on your investments but the CFD provider will not buy back your CFD before it is too late. On the open market you may not lose as much, but this does not mean you should not trade CFDs. This just means you must be wary of this possible disastrous financial pitfall.

There are many ways to make money.

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