CFD Trading Strategies Every Investor Must Know
CFDs or Contract for Difference are derivatives that allow live trading on price movements without the need to own the underlying instrument pertaining to your contract. In this type of contract two parties agree to exchange the difference between the opening and closing price of a contract. There are thousands of market to trade, which gives you exposure to a variety of shares, indices, commodities, currencies, and much more. In addition, there are a number of CFD trading strategies you can implement to achieve maximum profits and limit losses.
Trading with a low investment
CFDs can be used to speculate on the movement of both rising and falling markets. The objective is to go short or sell in order to profit from falling prices. It can also be used to hedge your portfolio to offset any potential losses. It is possible to trade by paying only a small fraction of the value of the contract which leads to a better return on your investment. Brokers charge a margin rate generally between 5% and 25% of the total trade value. For example, if a broker’s margin rate is 10% and you want to purchase 1000 shares of Texaco at $10 per share. You would need to make a deposit of $1000 (1000 x $10 x 10%) plus commission to trade $10,000. Margins vary among brokers with those for indices CFDs as low as 1.5% while currency and commodity CFDs begin from 1%. Remember, very high leverages can could also result in losses greater than your initial deposit. Therefore, you need to implement CFD trading strategies wisely.
Short term and long term strategies
The cost of CFDs is significantly low when it comes to investing, which makes it ideal for short term trading. In addition, you don’t need to pay stamp duty, which makes it all the most attractive when you want to profit from short term price movements. One of the most basic appeals of CFDs is their cost and timeframe. This makes short-term trading or intra-day trading an appealing strategy. The fact that CFDs are a naturally leveraged product – meaning you are effectively investing more than your available resources – and because of the added benefit of not having to pay any stamp duty, it makes them attractive for investors hoping to profit from short term price movements even from hour to hour or minute to minute. Alternatively, you can opt for a long term CFD trading strategy to capture bigger price moves where the timeframe can vary from a month to a year and more. Long term trading strategies in CFDs present a greater ability to forecast underlying market trends.
Going long vs. short
When you expect an asset to gain value over the life of a CFD contract you can opt for a ‘long position’ which is to purchase an asset. On the other hand, you will need to sell an asset at a specific level, also known as a ‘short position’, when it loses value over the life of the contract with the intention to buy it back at a later date. In this scenario, if the price begins to rise instead of fall, you will end up with a losing trade equal to the difference between the opening and closing price.
Pairs trading strategy
In this strategy, when the direction of the market is uncertain you could go long on one market and simultaneously go short on a similar or weaker market. Opt for a long CFD in a company whose price you deem to be undervalued and short on a more expensive share in a similar weaker market. For example, you may buy CFDs in Coke and go short (sell) Pepsi.
Swing trading strategy
This strategy allows you to benefit from smaller reversals in the price of an underlying asset within larger trends. For example, in a bullish market where prices are likely to retrace below previous highs during specific periods you can use these periods to purchase CFDs on the assumption that the price is likely to move upwards. In a bear market, the reverse is true where you can initiate short positions. One of the biggest benefits of this type of strategy is you can identify and forecast trade easily since they are easy to spot and tend to continue. No matter what type of CFD trading strategies you implement this type of trading is like spread betting which also carries a higher element of risk to your capital. Make sure that you fully understand the risks involved and determine whether CFD trading suits your style of investing best.