The Financial Conduct Authority, the UK financial regulator, recently announced that it had conducted a review of the procedures used for taking on new clients by 10 firms that offer CFD trading. One area in particular that it focused on was the degree to which brokers are carrying out assessments of their potential customers, and in particular their level of trading experience and familiarity with margined trading products like Contracts for Difference.
CFDs are very popular trading instruments globally, used by big banks, hedge funds and private traders. They provide investors with the potential to make larger profits from relatively small moves in financial market prices. However, with this also comes the potential for larger losses, particularly during periods of market volatility, or if the investor is not used to trading CFDs.
One of the reasons we founded The Armchair Trader was to provide new traders with objective education on a range of factors that need to be considered before opening a ‘live’ CFD trading account. In particular, it is important that traders recognise the enhanced risks that come with CFD trading, and that it can be easy to lose more than the initial investment.
The FCA said brokers should do more to ascertain the relative level of experience and knowledge that clients bring with them and should also do more to manage clients that fail to meet the broker’s initial risk assessment – should brokers allow traders to access CFDs having issued them with a risk warning letter? Are they doing enough to educate new traders
In an open letter to the industry, the FCA said: “Given the poor results that we observed across our sample, we are concerned that there is a higher risk that CFD providers industry-wide are not meeting the requirements of the rules when taking on new clients and/or are failing to do enough to prevent financial crime.”
It went on to say: “We were also concerned to find that firms’ communications did not meet our expectations. As an example, risk warnings given to clients did not convey in a clear and fair way that the product was not appropriate for the customer.”
We at The Armchair Trader would urge new traders to take plenty of time to educate themselves on the risks inherent in CFD trading before opening a live account. This can include reading up on the topic (there are a number of books on the market suitable to beginners) and making full use of demo platforms to try out trading strategies before committing real money. It is also worth gaining experience with less volatile markets, or, if the option is there, with a higher margin rate (e.g. 20-25% if the broker offers it).
You can read the CFD Regulation letter in full here. We will be exploring the topic of risk management in more depth on this site in the future. Make sure you return on a regular basis to catch up with the latest in our educational series.