Trading help, book reviews, risk management, and interviews.

Disclaimer

The contents of this blog do not constitute investment advice. Trading CFDs and Forex can be very risky and you can lose much more than your initial deposit. Seek professional advice before making any trades.

How much money could I lose trading CFDs?

Before placing any contracts for difference (CFD) trades you should ask yourself the question of “How much money could I lose?”. If you are to trade responsibly you should always be focusing on what you could lose, not what you could win. If you are focusing on how much you could win then you are either at high risk of losing a lot of money, or you could even be a gambler rather than a trader.

There are several different ways of looking at how much money you could lose.

Lose as much as you put in

A small number of CFD providers will cap your losses at the amount of money you have in your account (or offer a lower risk account which guarantees this). If you have an account with a company who does this then your worst case loss is obviously whatever money you put into your account.

Even if your CFD provider doesn’t cap your losses then you may be able to fix your maximum risk by using a guaranteed stop. Unfortunately there is usually an extra charge for these, often in the form of a larger spread.

Lose your entire position size – going long

Most CFD account providers have agreements that say you must cover all your loses – which can be larger than your account balance. They will usually close out your trade before your account balance hits ‘0’ but in a very fast moving market you might be closed out with a negative balance.

If you are betting long then your theoretical maximum loss will be your total position size. If you bought £10,000 of Vodaphone shares using CFDs then you may have only needed to put down a £100 deposit (if we assume a 1% deposit requirement) but your loses could far exceed that £100. Your maximum loss would occur in a situation where the share price went down to 0. If you’d used CFDs to buy £10,000 of shares and the price suddenly plummeted to 0 then you could owe £10,000 if your trade wasn’t automatically closed out.

Could this happen in real life? Certainly share prices can go down to 0 – recent cases of large companies collapsing include Enron and Lehman Brothers.

If you were going long on indicies, such as the FTSE 100 then your theoretical loss would be the loss that would be incurred if the index went down to 0. As I write this the FTSE100 is at 4365. If I bought at £1 a point then my theoretical risk is £4365.

Unlike shares which can go down to 0 a share index is very unlikely to. It the FTSE 100 ever dropped to 0 then that would probably mean that the UK had been nuked to oblivion. In which case you may well be dead and your CFD broker wouldn’t exist either! Very unlikely but it is always worth bearing in mind just how much money you are playing with.

Could the value collapse so fast that you would end up owing far more than your account balance? You can end up owing your CFD provider more than you balance if you have a very large and highly leveraged position, and things move fast. In this case it may simply not be possible to liquidate your position fast enough to prevent your loses.

Losing a fortune – going short

The amount you can lose is often defined in terms of prices going down. Of course with CFDs we can bet on prices going up and down. How much could you lose by going short?

In theory you could lose an infinite amount of money!

I’m not saying it is likely – just theoretically possible. Lets imagine that you think UselessPowerPLC is going down. It is at 5p per share and you think it will fall further. You sell £10,000 worth – this is 200,000 shares. It is a small share and you need a 10% deposit. In other words you have to put down a £1000 deposit. They make an unexpected announcement – they have perfected fusion power, using patented technology, and can now produce almost unlimited amounts of power extremely cheaply. The company will make billions! The share price rockets to £20 and moves so fast that your CFD provider can’t close your position out in time. Suddenly you owe your CFD provider £3,990,000 (200,000 * (£20 – £0.05)). Yes – nearly £4 million. Crikey. Stretching the bounds of believability perhaps, but it makes a point about how risky the CFD game could be. Especially if you make stupid bets!

Is any of this really likely to affect me?

How fast could prices move? Very fast. Look at the stock market crash page on Wikipedia. How would your account have coped during one of those days?

My doom-munging scenarios wouldn’t normally happen of course. You CFD provider knows that trying to claw back debts from customers is much harder, and more expensive than simply deducting the money from their account. This is why they have automated systems in place to try to automatically close your positions before you get into this predicament. If you do find yourself in this predicament then you should look at the way you are trading – it probably means you did something very stupid, i.e. holding positions that were far too large and highly leveraged.

Although the unlikely is by definition ‘unlikely’, is always worth thinking beyond your usual risk scenarios. Don’t forget that a factor of the current credit crunch was that banks rejected the sudden default of hundreds of thousands of mortgages as being such an unlikely thing to happen that it wasn’t worth taking seriously. Ooops! Fortunately the banks had the government to bail them out. If you mess up then the banks certainly won’t be bailing you out.

The simple moral – consider the usual risks, and then consider beyond the usual risks. If you are still happy then you can play the CFD game. If you aren’t happy then maybe you should put you money in the bank.


Reader Feedback

4 Responses to “How much money could I lose trading CFDs?”

  1. Vick says:

    Best Advise I HAVE LOST 20000 IN 2 MINUTES WHICH I EARNED IN 5 MONTHS

  2. Vick says:

    NEVER PLAY CFD IF YOU HAVE HARD EARNED MONEY< I NEARLY LOST MY HOUSE AND DUE TO STRESS I AM OFFWORK

  3. Steve says:

    That’s a lot to lose in 2 minutes Vick!
    Where do you think you went wrong?
    Cheers.

  4. DjSicK says:

    CFD’s are generally pretty retarded. The whole point is to borrow cash then use it on the stock – market. It’s like borrowing money for a investment – never do it unless your 100% sure about it, and with CFDs you will never be.

    Lame to hear Vick, good luck in the future!

Leave a Reply

Do NOT fill this !