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Trading The Markets: Just How Risky Are CFDs And Binary Options?

Trading The Markets: Just How Risky Are CFDs And Binary Options?

Not so long ago, financial markets were pretty much a closed book to all but the privileged few.

Amateurs weren’t exactly encouraged – and if you wanted to dabble in trading, then at the very least, you needed plenty of spare cash and the telephone number of a stockbroker.

But then, of course, along came the internet; and with it, a new generation of online trading and brokerage platforms designed to make trading open to everyone.

And it’s not just about direct share dealing: even previously out-of-bounds areas such as the foreign exchange markets and derivative instruments are now fair game for part-time traders.

So what’s the best way to take a punt with limited funds – and without being exposed to huge losses if a trade goes wrong?

Contracts for difference (CFDs) and binary options have both become widely available over recent years, with each product billed as an accessible, user-friendly way to trade.

So are they something you should consider? We take a look…

Binary options and CFDs: what are we talking about?

Trading The Markets: Just How Risky Are CFDs And Binary Options?

Binary options and CFDs are both forms of ‘derivative’ trading vehicles. In other words, they relate to the price of a particular asset – but without the trader actually taking ownership of that asset.

CFDs and binary options might relate to the share price of a particular company, a commodity, foreign exchange currency or share index (the FTSE 100, for instance).

With each product, there’s the possibility of making a profit or loss as a result of small movements in the price of the underlying assets over a short period of time.

What’s more, the opportunity to go short or long (i.e. to decide on the price of the asset falling or rising), gives you the potential to turn a profit no matter what the market conditions.

Binary options tends to be fast-paced; you choose your asset, choose your expiry time – and essentially take a position on whether the price of the asset is going to be above the ‘strike price’ (the price of the asset at the time the option is executed) come expiry time.

CFDs are more complicated. The ‘contract’ is between the broker and the trader, and the ‘difference’ refers to the difference between the strike price and expiry price.

With binary options where it really doesn’t matter how far the asset price moves above or below the strike price; you either receive a fixed amount – or you lose your stake.

A CFD by contrast, is a leveraged product: your profit or loss from the contract is related directly to how far the price moves away from the strike price.

The more it moves in your direction, the more you are paid out. The more it moves in the opposite direction, the more you lose – raising the possibility of your losses significantly exceeding your initial outlay.

When leverage becomes a problem…

Trading The Markets: Just How Risky Are CFDs And Binary Options?

At heart, CFDs are essentially technical hedging tools that have morphed into products for the consumer market. For big institutions heavily invested in a certain asset, taking a short position on the very same asset with a CFD might make sense.

It is, in effect, an ‘insurance policy’ against the possibility of that asset leaking value. As a way for consumers to invest, CFDs are both sophisticated and fast-moving  – and certainly aren’t for everyone.

First and foremost, you must ensure that you have sufficient funds in your trading account to cover your total margin requirements; something that can certainly be a challenge if you have multiple CFD trades on the go at the same time. As a rules, the narrower the spread (i.e. the gap between the buy and sell prices).

By contrast, if you want to put your knowledge of the markets to work – but with absolute certainty on the level of profit or loss you are exposed to, binary options make much better sense.

Choosing the right platform

Some online platforms (ETX Capital and CMC Markets, for instance) offer the ability to trade with both CFDs and binary options. While there are some broker comparison websites, when weighing up the pros and cons of the many platforms out there, it’s definitely worth looking beyond the marketing spiel and ask the following questions:

  • Is this platform safe to use and independently regulated?
  • Is the fee structure transparent and fair?
  • Does it give me the tools I need to stay in control of my trading activity and make the right trading decisions?

There’s no such thing as ‘guaranteed success’ from trading with either binary options or CFDs. Reading market signals, spotting opportunities and strategy building are all skills that need to be honed over time.

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