Tips, tricks and strategies of CFD trading
CFD trading has become a popular way for speculators to invest all across the world, and there are two particular reasons why CFD day trading is so popular. One is leverage and the other is cost. You may have been thinking about having a go at this type of trading yourself but don’t know where to start. That’s why we put together this guide. It contains helpful hints and tips, not to mention a few warnings, that should help to get you started.
Now, you’ll notice the word ‘warnings’ there, and we think it’s probably best to mention them upfront. Something like 74-89% of retail investor accounts haemorrhage cash when CFDs are traded. That’s a sobering statistic, or at least, it should be. The nature of leverage ensures that you can make a large wad of cash very quickly, but equally, your account can be emptied just as fast. That’s why we stress that you need to go in with your eyes well and truly open. You really need to know what you’re doing, so let’s start the ball rolling.
With CFD trading you’re making contracts that involve you and someone else. The contract stipulates that you will pay the difference between the opening and closing prices of whatever it is you’re trading in. So, it’s a way of betting on the direction that you think a price for an asset will move, but without actual necessity to own it.
The way the CFD performs will depend on the asset that underlies it. You’ll make a profit or a loss according to how it moves compared to the opening price.
In this scenario, you choose a stock that has an asking price of $50 and you open a CFD worth 100 shares. This would cost you $5000 if you were purchasing them using the traditional approach (not forgetting that you also need to add on any costs for trading or commission later).
But, if you go through a CFD broker you’ll benefit from a margin of just 5% (always remembering that margin levels will vary between brokers), which means that the trade would only cost you $250. The advantage of this kind of arrangement from the trader’s point of view is pretty obvious.
When you look at your CFD, such a position will reveal a loss that matches the size of the spread, so if your broker’s spread is 5 cents, you’ll need to have your investment improve by the same amount if you’re going to break even.
Still using this last example: let’s imagine that the price of the underlying stock doesn’t stop going up and hits a bid price of £52.00
If you owned the stock, your holding would have risen to $5200, representing a tidy profit of $200 (though we are leaving out trading costs and commission right now)
But, with the underlying stock at $52.00, the CFD would show the same $200 profit, although it didn’t cost as much to open, a mere $250. So, percentage-wise, the CFD delivered much greater profits. Of course, if it had gone in the other direction, the loss would have been just as big.
We should also say that there are advantages in trading assets, but we’ve left them out here just for the sake of simplicity.
We’ve mentioned some already but let’s sum them up:
There’s always a downside, even with the best of things. Here are the ones you’ll find with CFD trading:
CFD trading it is pretty easy to get into. Here are some recommendations to get you going:
There are literally thousands of markets to get involved with. You can search one that suits you using the search facilities that come with many online services. Be sure to choose a market that you feel familiar with. To get the best returns you’ll be focusing your attention on volatile liquid markets, things like oil, cryptocurrencies and currency pairs, for instance.
Buying is called going long. Selling is called going short. Pull up the trading ticket in your browser to view the current price. The first number is the bid (selling price). The second number is the offer (price you buy at).
If you think that the market will go up, you should buy, and if you think it will go down, then you should sell.
Now it’s time to choose the size of CFDs for your CFD trading debut. With a CFD, you decide on how big your investment is, which means that even though the underlying asset’s price can vary, you invest as much as you see fit to. Brokers do have trading minimums that vary across assets, but they’ll always tell you what your total exposure is.
Assets as volatile as Ethereum or Zcash will usually require bigger margins. So, a position with exposure to $2000 worth of Ethereum might command a margin of $1000 for instance, whereas with a blue-chip stock it might only be 5%. So, a $4000 position on General Motors will only cost you $200.
You can think of stops as railway buffers that halt your runaway trading train. A stop loss automatically closes a trade when the market reaches the level you’ve set, and it’s a no-effort way to limit risk.
A limit order tells your platform to close a trade when the market hits a certain limit above the current level. Trading bots can execute your trading plan for you and are ideal for closing trades when your eyes can’t be everywhere at once.
When you’ve set your limits, your profits will move with the market price. Market price is available to watch in real time on most platforms so you can always add or close trades. And you still have the option to manually close trades yourself whenever you like, too.
If that’s what you decide to do, then just choose ‘close position’ in the positions window and see how much you made or lost straightaway.
Even if you know your chosen market quite well, you’re going to need a strategy, and one that fits with your style of trading. It should be something that sits well with your financial situation, how well you can weather risk and your own unique abilities, which might include your talent for deep analysis, for instance.
Here are two widely-used and effective CFD trading strategies and tips that we’ve outlined:
This just means setting a price for a particular security, a level that you will buy and sell at according to trends. In this arena you should steer clear of trades when the market can’t give you clear signs, so if you haven’t got a clue which way it’s heading, stay away. If you do hang around, your talent for deep analysis may be your best ally.
No trend can keep going indefinitely, and this strategy can put money in your coffers if you can pinpoint the moment when they’ll change.
If a stock’s price has been on a downward trajectory, then you identify a point where you believe it’s near the end of the trend. Then you enter a buy position because you anticipate that the trend will pivot and head off the other way. You’ll short a stock that’s been rising in price when you think it’s about to plummet, and conversely, you’ll go long if you think a sinking share is about to spike. You can lean on analytical tools and wave theory too, to help you work out when such lucrative events will happen.
Leverage can be addictive. When a trade is on the up it can be tempting to increase the size of your position, but just as one win at the roulette we’ll can trick you into betting the house, it can also make you lose your shirt.
So, begin small, and limit your exposure in line with your capital (meaning a 3:1 ratio to start with). As you learn more and it grows, you can gradually increase your leverage.
Journals aren’t just about your heartache - a trading journal will keep your emotional turmoil to a minimum. Keep a tally of entry and exit points, price, position size and the like, too. Hindsight is always 20/20 so this will help you monitor mistakes. CFD trading journals are a great way to write yourself smarter, just remember to include these elements:
• The instrument
• Time of entering and exiting the trade
• Reasons for it, technical, news-story, etc.
• Was it a profit or loss?
• How you performed, and whether you followed your own rules!
• What the trade taught you
This may seem like a lot of work, but you’ll thank yourself for it in time. Better decisions will become second nature do you as a result and your trading account will look healthier than ever.
Stops put the brakes on losses, so every single trade you enter needs a CFD stop. Your emotions can trick you into letting losses run, but your stop will not give them any emotional leverage over you! Set your CFD stop in a quiet moment (not during the heat of battle) and stick to it. You’ll be glad you did.
A demo account helps you put all your careful research into practice, and practice lets you test without risk. Lots of brokers offer practice accounts. The money isn’t real, so you can make mistakes with complete impunity. It’s not just about testing your strategies either. It’s all about becoming more familiar with CFD trading markets and test driving the actual trading platform. When you can make money consistently in the demo account it’s time to go live.
Even when you’re doing well you shouldn’t turn your back on learning more. Markets are always changing, and strategies can always be improved. These days, successful traders are only too happy to share tips and insights online, and there are more books being written on the subject every day.
CFD trading goes on in many jurisdictions across the globe, so you should be aware that every market has its own unique characteristics. Taxes are one of the biggest differentiators between them because every country looks at CFDs in a slightly different way. Some view them as gambling by another name, so they don’t tax them, while others treat them the same as any other type of income and sting you accordingly.
In the UK, for instance, CFD trading is subject to capital gains tax. There is a $10,100 annual exemption, but if you do make any profits above that threshold then they will attract the gaze of the taxman. This is one reason why keeping a very detailed account of all your transactions is essential. So, before you can begin trading, it’s important to understand your tax obligations so you can shape your money management strategy.
Becoming a successful CFD trader requires a lot of investment in your own education, a lot of practice and patience to succeed. But many others have done this already, and there’s no reason why you can’t too! Good luck.