What are the risks of buying or trading stocks?
Risks of buying stocks outright
The main risk involved in buying stocks is that the company gets into difficulty and goes bankrupt, or that the share price falls to zero. If this happened, you would lose your initial outlay – however with investing, this is always the most you stand to lose. For example, if you’d invested £1000, the most you could ever lose if the share price fell to £0 is £1000.
For some investors, the risk of a short-term decline in share prices can be offset by the popular strategy known as hedging. Alternatively, other investors might choose to diversify their holdings by investing in or speculating on the price of exchange traded funds (ETFs) – these are baskets of stocks that track the underlying market price movements.
Risks of trading stocks CFDs
The risks posed by trading stocks CFDs are significantly different due to leverage. One such risk, is the risk of trading on leverage (or margin). When you trade on margin, both your profits and losses are calculated on the full value of your position, rather than this initial outlay. This means that although you have the possibility of magnifying your profits, you also could magnify your losses and your losses can exceed your deposits.
However, there are tools that traders can use to manage this risk. For example, stop-losses enable traders to define their exit point for trades that move against them, while limit orders will close a trade after the market moves by a certain amount in a traders’ favour.
Also, if you decide to short a stock – either traditionally via a broker or with derivative products – you would be open to an unlimited downside potential. As, in theory, there is no limited to how much the share price could rise by.
It is important to remember that trading CFDs may not be suitable for everyone, and your should ensure you fully understand all the costs and risks involved by reading the Risk Disclosure Statment and Risk Fact Sheet.
