Need to know
- Contracts for difference (CFDs) were the most frequently purchased investment product since March 2020, and 42% of the investors lost money
- In October 2020, ASIC issued a product intervention order on CFDs for retail investors
- The intervention reduced aggregate losses by 91%, from $372 million to $33 million per quarter on average
With hundreds of investment-related platforms available to Australian consumers these days, access to the share markets has never been easier.
Many of these platforms, in fact, urge their users to trade and trade often. But easy access shouldn't be confused with easy money.
Judging by research released by the Australian Securities and Investments Commission (ASIC) in August last year, Australian retail investors have a healthy appetite for risk.
(Retail investors are non-professionals – everyday Australians who, in many cases, try investing in hopes of having an additional source of income or, in other cases, landing a lucky windfall.)
As a case in point, a survey that informed the ASIC research revealed that cryptocurrencies are the second most popular form of investing after Australian shares, and only one in five cryptocurrency investors considered the investment risky.
The ASIC research also found that those who were new to investing were more likely to trade in cryptocurrencies than older and more experienced investors.
And over half of the new investors ASIC heard from were between 18 and 34 years old, a cohort whose risk tolerance appears to be on the high side.
Those who were new to investing were more likely to trade in cryptocurrencies than older and more experienced investors
Aside from their notorious volatility – a key dynamic of risk – cryptocurrency investments can often turn out to be cryptocurrency scams, which can disproportionately affect inexperienced investors hot on the trail of a big payday.
ASIC Chair Joe Longo said in August 2022 that half the people the regulator surveyed reported that they started investing because they didn't want to miss out.
"This, coupled with more complex and opaque financial product and service offerings, and the speed and reach of marketing and distribution through digital channels, may expose investors to new risks or higher levels of existing risks," Longo said.
Gambling on contracts for difference
But there's another type of investment strategy that is perhaps even riskier than cryptocurrencies – contracts for difference, or CFDs.
A CFD is a contract you make with a CFD provider (such as a broker) through which you speculate on the short-term price movement of an asset. This could be a foreign exchange rate, a crypto asset, an individual share, or a market index (a collection of shares, like the S&P 500, that represents a particular segment of the financial markets). You are betting on the asset going either up or down.
Aside from the unpredictability of price movements, the dangerous thing about CFDs is that you only pay a small deposit (or 'margin') on the full value of your position upfront, a technique known as leveraging. You could pay as little as three percent, for instance, of the full amount of money at play.
This is possible because you never actually own the asset you are buying or selling; you're only speculating on its price movement.
If the price moves against your CFD position, you'll have to pay the difference ... This could be many times the amount of money you originally put in
But while you only pay a small deposit upfront, your profit or loss will be based on the full value of your position.
If the price moves in your favour, the CFD provider pays up. But if the price moves against your CFD position, you'll have to pay the difference in price to the CFD provider. This could be many times the amount of money you originally put in, because of leveraging.
You are also on the hook for any fees, charges and interest the provider may charge you. It's a risky investment strategy and losses can be high.
There are other concerns as well, including whether you can trust the CFD provider (or 'counterparty') to hold up their end of the bargain.
But the risks haven't stopped people from scooping them up.
42% of the investors that were surveyed said they had either sold a CFD for less than they bought it or, in some cases, lost all their money
According to the ASIC research, CFDs were the most frequently purchased investment product since March 2020, and 42% of the investors that were surveyed said they had either sold a CFD for less than they bought it or, in some cases, lost all their money.
Recent investors were significantly more likely to trade in CFDs than experienced ones.
ASIC imposes new CFD rules
In October 2020, ASIC issued a product intervention order on CFDs for retail investors that placed limits on the ratio amount of money that could be leveraged) and put in place negative balance protections. The order also targeted "features and sales practices that amplify retail clients' CFD losses".
The intervention came after an ASIC investigation determined that retail clients of 13 CFD issuers lost a collective $774 million over a five-week period in early 2020
It wasn't the first time the regulator had sounded the alarm. Reviews of the CFD market in 2017, 2019 and 2020 found that most retail clients lose money.
Retail clients of 13 CFD issuers lost a collective $774 million over a five-week period in early 2020
The intervention order took effect on 29 March 2021 and was expected to be in place for 18 months. In April 2022, ASIC extended it for another five years.
The order had the intended effect, reducing aggregate losses by retail CFD investors by 91% (from $372 million to $33 million per quarter on average) according to the regulator.
But it wasn't of much help to people who suffered CFD losses before the March 2021 intervention.
Class action follows $800 million in CFD losses
In May 2023 the law firm Piper Alderman and litigation funder Omni Bridgeway announced a class action against UK-based IG Markets in a bid to enable Australians who traded in CFDs within the past six years to recoup some of their losses. IG Markets calls itself "Australia's No. 1 CFD Provider".
Up to 20,000 retail investors in Australia potentially lost a collective $800 million or thereabouts because IG Markets "marketed and facilitated the trading of complex CFDs to inexperienced investors" without adequately assessing their financial situations and objectives or disclosing the risks, according to the law firm.
There is evidence that highly-leveraged CFDs should never have been marketed to everyday Australian investors who had little or no experience in trading such complex productsPiper Alderman partner Kate Sambrook
Piper Alderman partner Kate Sambrook says "there is evidence that highly-leveraged CFDs should never have been marketed to everyday Australian investors who had little or no experience in trading such complex products", adding that "the class action seeks to provide a remedy and recover these losses for retail investors who should never have been exposed to trading in such complex, high-risk products."
The lawsuit comes on the heels of other grievances. SInce 2018, there have been over 200 complaints to the Australian Financial Complaints Authority about IG Markets.
Only one in five cryptocurrency investors surveyed by ASIC considered the investment risky.
'It's easy to take a big hit'
One former retail CFD investor who spoke with CHOICE says he's no longer comfortable investing in a product that involves such high leverage .
"The thing with CFDs is that you've got leverage, so you can invest a small amount of money and have a rather big position in the market," Markus (not his real name) tells us. "So it's very easy to take a big hit."
Calculated as yearly interest, I found out they had charged me about 200% interestContracts for difference trader 'Markus'
After about a year of investing in CFDs, Markus had lost roughly half his money. He says he made some of this back, but was blindsided by another issue.
"I found out that they charge you interest if you're on a margin. And that can vary a lot. Sometimes it's a huge amount of interest, and it's not easy to find this out. When I was expecting a win, it turned out to be a loss. Calculated as yearly interest, I found out they had charged me about 200%."
Markus says the interest rate disclosure was probably buried in the fine print.
'Aggressively and effectively marketed'
Dr Elvis Jarnecic, a senior lecturer and investment expert at Sydney University, says contracts for difference can be particularly tempting for newcomers.
"These products are aggressively and effectively marketed and require minimal capital investment, hence they do attract mainly retail and relatively inexperienced investors," Jarnecic says.
There is definitely a strong case for greater regulation, improved oversight and stricter limits on the exposure of individual tradersDr Elvis Jarnecic, Sydney University
"From a behavioural perspective, very simply, they are attractive as they provide higher return opportunities, but also at greater risk."
While stopping short of calling for a ban on CFDs, as in the US, Jarnecic says there is a case for continuing regulatory oversight.
"There are many non-financial products in the market such as lotteries and other forms of gambling that are no less risky and lack any fundamental information to guide investment," Jarnecic says.
"CFDs are, however, mostly traded by retail investors and allow enormous leverage, and for that reason there is definitely a strong case for greater regulation, improved oversight and stricter limits on the exposure of individual traders."
Markus's experience with CFDs has led to a philosophy that would likely serve inexperienced investors well. "There are a lot of advertisements out there that make you believe you can make a fast buck, which of course is not true," he says. "Most who try, fail."
Stock images: Getty, unless otherwise stated.