CFDs are complex financial instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money. CFDs are complex financial instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

Using trading and investment products

Lesson 5 of 6

What are the risks of combining trading and investing?

There’s no getting around the risks associated with derivative products. It’s easy to lose track of the financial liability involved in trading with leverage. A leveraged trade going against you can cause damage to your wealth because any losses you incur are amplified. With a share dealing portfolio, you can’t lose any more than the initial value of your shares, but with derivative instruments you could lose more than you invested.

It’s incredibly important to use resources like demo trading environments before you start participating in the financial markets in this way. You can sign up for a free demo account loaded with $10,000 in virtual funds. Use it to get a feel for how much exposure you’ll get and at what margin.

If you’re using multiple products, it’s important to consider your whole portfolio in your risk management strategy. Don’t let short-term excitement become a hindrance to long-term wealth building. If executed poorly, a multi-product strategy can also introduce more risk to your portfolio.

For instance, you can reduce the diversification in a portfolio when you open trades that are highly correlated to your long-term holdings. This leaves you exposed to making losses in both your shares and your leveraged positions.

Example

Consider this worst-case scenario. Say you own shares in a few gold mining companies and you trade derivatives on occasion.

You log in to your trading account one day and find that the price of spot gold is rising quickly. So, you buy ten standard contracts to try and profit from the rally (or increase).

The following day, news breaks about one of the biggest gold mines in the world caving in. It’s owned by one of the companies you’ve invested in.

The price of gold plummets well below your stop-loss level and you lose all your capital.

But because you also own shares in the company implicated, your portfolio loses money on two fronts.

Finally, both leveraged trades and investments incur costs. It’s important that you know of all the charges involved in making a trade – such as spreads, commission fees and daily funding charges. Overtrading can have a negative effect on your account balance because each transaction you make may have accompanying costs.

Because derivative products are designed to take advantage of short-term price movements, some of them are structured in a way that you’ll be charged a fee when you hold them overnight. Always factor in the money you’ll lose to fees when you’re considering opening a position.

Lesson summary

  • Not having a formalised strategy in place when trading multiple products can have adverse effects on your wealth
  • Costs and charges associated with trading and investing can eat at your funds if you don’t manage it
  • If diversification is executed poorly, it could leave your portfolio overexposed to risk
Lesson complete