Let’s say that Dan has decided he would like to start trading CFDs. After hunting around for a trading platform that offers the features he wants, Dan decides that a company he has been monitoring, Joe Bloggs Enterprises, is set to experience a big jump in its share price, so he “goes long” and buys 4,000 CFDs at £5 each – that means a total contract value of £20,000.
The CFD provider requires a 5% margin in order to open a trade, so this amount (£1,000) is deducted from Dan’s account.
Happily for Dan, the shares jump a massive 10% from £5 to £5.50, which sees Dan gain close to £2,000, almost doubling his initial investment.
Now, let’s say that Daniella has also been monitoring Joe Bloggs Enterprises and believed that the share price was about to go down. She “went short” and sold 4,000 CFDs at £5 each. Like Dan, she has a total contract value of £20,000 and puts down a 5% margin for £1,000. As the shares have gone up, instead of down, as Daniella predicted, she lost her initial £1000 and owes a further £1000.
This is why CFD trading is risky. Leverage allows both Dan and Daniella to borrow £19,000 to purchase their contracts. They are both at risk of losing more money then their initial investment, which Daniella ends up doing.