Using financial derivatives is a good way to get involved in the trading niche as there can be a host of financial markets to take advantage of and there is no need to own the underlying asset to make a profit. CFDs (Contracts for Difference) are one such product, and could help traders of all skill levels to make money, diversify their portfolio and more.
CFD trading in short
When you decide to use CFDs, you will be making an agreement with a broker to go in on a trading position together. When selecting a contract, two prices will be listed – the first being the sell price and the second the buy price – and it’s the difference between these (the spread) that the profit comes from. The practice of CFD trading is speculative and requires traders to anticipate the potential price movements that may occur. Positions can be taken by buying long (with price rises in mind) or selling short (considering price declines). If you’re looking to research more about what CFDs are, you can read more here.
CFD trading strategies
It can be worthwhile to implement a trading strategy when trading CFDs, to try and maximise profit potential and minimise losses. There is no expiry date on these types of trading contracts, so there are a host of different strategies that can be applied when trading.
If you are interested in day trading, a scalping trading strategy could offer the most potential. The aim is to use your CFDs to enter multiple trades in a day that have small profit margins. These little wins will add up to a larger profit, while spreading out the potential risks that come with trading in general. It can be time-intensive, but many platforms offer automated tools to balance out the commitment needed.
2. Pair trading
This trading strategy increases the potential for gains by opening contracts on two different assets in the same industry. The goal is to open a long position on a better-performing asset and a short position on one that is experiencing a drop in price. The focus comes on how these move in relation to each other and the more they separate, the greater the profit potential.
3. Swing trading
A lot can be said for market trends and the insights they can offer to trading and this is exactly what a swing trading strategy focuses on. When following the behaviour of an asset and predicting whether the direction of the trend will continue, traders can not only exploit the information, but also indicate potential resistance levels to know when to exit positions at the best possible price.
Hedging can act as an insurance measure when CFD trading, protecting contracts from the short-term drops in value that can spell losses. This can be a worthwhile strategy to add alongside others to improve the quality of trades and even diversify portfolios.
The risks of leveraged trading
As CFDs use leveraging, it’s important to understand the potential risks that can come when using the support of a brokerage when trading. The main concern is that while profits can be increased when entering more valuable positions, the losses are also magnified. As traders only put down a margin sum, there is the misconception that losses are only equated using that number, but in reality, they are taken across the value of the entire spread. This means that you may be unaware of just how significant losses can be, but also that they can quickly mount up. Manage your risk by researching the markets and making use of stop losses.
CFD trading tips
With all of the above in mind, it can be worthwhile to consider a few extra tips when trading CFDs. For instance:
- Research is going to be your best asset when taking up CFD trading
- Traders may benefit from creating a trading plan and implementing it for every trade
- Market analysis can work alongside even the strongest trading strategy for increased profit potential
- Always have your budget in mind, never trade more than you can afford, start small and practice with demo accounts before putting real funds on the line
- Always practice risk management
When you have kept these things in mind, have a good trading strategy (or two) in place and trade using a reputable brokerage, CFD trading could be a worthwhile endeavour.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.Marketing for CFDs and spread betting is not intended for US citizens as prohibited under US regulation.