CFDs let you speculate on short-term market movements. Like foreign exchange rates, share prices, stock market index levels, cryptocurrency rates or other underlying assets. Most people lose money trading CFDs.
Your gain or loss depends on the price of the underlying asset when the contract starts and ends. If the price moves in your favour, the CFD provider pays you. If the price moves against your CFD position, you pay the provider.
What is CFD trading
A CFD is a derivative, which means its value is based on another asset, like a share or index. But, unlike shares, when you trade a CFD you don't own the underlying asset. Instead, you speculate on its price movement.
You agree to pay the difference in price of the underlying asset between when the contract opens and closes:
- if you 'buy' a CFD (a 'long trade'), you expect the value of the asset to increase
- if you 'sell' a CFD (a 'short trade'), you expect the value of the asset to fall
You pay transaction costs and other fees to the CFD provider.
A CFD contract is legally binding. If the market goes against you, the CFD provider:
- will ask you to pay extra money at short notice to keep your CFD position open (a 'margin call'). This may lead to further losses
- may close out your CFD, for whatever it's worth at the time. You may lose all the money you invested
CFD contracts are not all the same. Every CFD provider has their own terms and conditions. You rely on the provider to fulfil their obligations to you.
Look for details in the product disclosure statement (PDS) and terms and conditions.
There are restrictions on the sale of CFDs to retail investors in Australia.
Providers must:
- apply 'margin close-out protection', to end one or more open CFDs before all or most of the investment is lost
- limit retail client losses by providing 'negative balance protection', so they can never lose more than they invest
They must not:
- exceed specific leverage ratio limits, depending on the CFD asset class
- offer incentives to trade CFDs, such as trading credits and rebates, or 'free' gifts like iPads
Read more about ASIC’s CFD Product Intervention Order.
Why CFDs are high risk
CFDs are complex and high risk. Even experienced investors may struggle to understand the risks and complexities of trading CFDs.
Most retail clients lose money trading CFDs. Consider whether you can afford to lose your money.
Leverage can lead to large losses
CFD leverage is like trading with borrowed money. The deposit (or 'margin') you give to the provider is a small part of what you borrow to invest.
Leveraging and trading on margin is highly risky. A small price change against your CFD position can have a big effect on your trading returns or losses. You can quickly lose your entire investment.
For example, you may have to put up $5,000 (5%) for a $100,000 contract. This means you are borrowing the other 95%. A 5% change in the underlying asset price could mean you lose your $5,000.
Consumer protection may not apply with overseas CFD providers
CFD providers operating in Australia must have an Australian financial services (AFS) licence. Overseas CFD providers often don't hold an AFS licence, so consumer protection under Australian laws will not apply.
This means you will not have access to independent dispute resolution through the Australian Financial Complaints Authority (AFCA). If something goes wrong, you may not be able to get help.
If the overseas provider does not hold an AFS licence, it could be a scam.
Wholesale clients lose consumer protection
Some firms may try to classify you as a 'wholesale client', rather than a retail client. They could ask you to sign up to a 'pro-account' and describe the benefits.
But if you're a wholesale client, you:
- may not have 'negative balance protection' or 'margin close-out protection' on your CFD. So you could lose more than the amount you invest
- waive your right to use the CFD provider's internal dispute resolution service
- cannot get external dispute resolution through AFCA
- may not receive a product disclosure statement (PDS) or financial services guide for the CFD
- will not be assessed to see if you fit the licensee’s target market
To check how you are classified, read the PDS issued by the CFD provider.
How CFDs are distributed
Only a licensed CFD provider can issue CFDs to retail clients in Australia. That means your CFD contract is with the provider, and you pay them for the transaction.
An authorised representative or introducing broker can tell you about CFDs, but they cannot sell them to you directly:
- Authorised representative – arranges for a licensed CFD provider to issue CFDs to you
- Introducing broker – must be licensed or authorised by a licensee, and arranges for a licensed CFD provider to issue CFDs to you. They are typically paid a referral fee for your business by the CFD provider
Always check that the product is issued by a licensed CFD provider, by reading the PDS.