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Is it more risky to short a CFD than go long?

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By Expert Panel 27.08.2012

Question:

Is it more risky to short a CFD than go long? And how do you trade a CFD short, for example, what happens to interest charges, dividends etc?

Thomas Roberts

 

Thomas Roberts, Financial Writer, IG Markets

Answer:

There are some traders who are bound to feel slightly insecure about going short on a financial asset with a CFD.  After all, you are aiming to profit from something losing its value, which seems quite oxymoronic.

In terms of actual CFD trading and its execution, going short carries no more risk than going long on a CFD.  It is highly recommended to consider this risk before you trade, given the geared nature of CFDs, but going short with a CFD will not subject you to any more additional risks.

In fact, opening a short CFD can be used to reduce risk against other assets in your trading portfolio.  For instance, shorting with CFDs can be used as an effective hedging strategy against your long-term investments in equities.  With the current financial climate behaving in a very volatile fashion, this strategy could be more relevant than ever.  It allows you to hold your long-term investments that you believe to be sound, while hedging against any short-term volatility that could well take place over the coming months.

Funding a short CFD is different than opening a long position or physically holding assets such as equities, but it is not necessarily as ‘risky’.  Overnight financing for a long CFD position involves a charge being levied onto your account on a daily basis, based on the Reserve Bank’s overnight cash rate, give or take two or three cents.  However, depending on the current interbank offered rate, with a short CFD position this charge can be earned and added to your balance, rather than it being taken away.  This is because a traditional share sale is simulated due to the short position.

A dividend payment on a CFD is an issue that can potentially cause problems.  If you hold a share CFD before the ASX open and on the morning of that company’s ex-dividend date, your CFD account will have a dividend adjustment posted to it.  If you were holding a long CFD position, you would have the dividend amount placed into your account.  A short position, however, would see that amount be debited from your account.  This is an important thing to consider before taking any position, as you will need to ensure that your account has sufficient funding to keep the position open.  Insufficient funding could easily compromise a hedging strategy or any other reason to keep the position open.

With the exception of dividends, opening a short position on CFDs should carry the same amount of risk as a long position.  This risk, of course, is one that should never be underestimated.  It is possible to lose more than your initial deposit with CFDs and in a volatile market this could happen quicker than you may think.  Therefore, it is important that you study the markets thoroughly before you invest and to also consider utilising risk management tools from your CFD provider, such as guaranteed stops or limit orders.  It would be wise to consider any CFD trade properly, whether it is a short or long position, in order to approach your trading with a careful, educated approach.
 
Thomas Roberts, financial writer for IG Markets.

Please consider the Product Disclosure Statement available from IG Markets. CFD trading can result in losses that exceed your initial deposit and you do not own or have any interest in the underlying asset.  This information does not constitute as financial advice.

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