Contracts for difference (CFDs) are a type of financial derivative, meaning when you trade in them you are not trading the underlying asset, but a contract that derives from its price.
Traders make an assessment as to whether the price of an asset will rise or fall over a particular time period. If the trader believes it could go up they open a long position, if they think it could fall they open a short position.
CFDs enable you to pay just a fraction of the value of your trade upfront, which is known as leveraged trading. This can magnify profits but also amplify losses, so you may want to consider risk management tools, such as guaranteed stop losses and stop-loss and take-profit orders.
There are a wide variety of CFD trading strategies individual traders should consider, taking into account their goals, risk tolerance and expertise in the market, among other factors.
Fundamental and technical analyses can be useful tools with many CFD trading strategies.
There are a number of CFD trading strategies, although traders should remember that there is always the risk of losing money and they should do their own research before making any trading decision. And never trade more money than they can afford to lose.
There are many factors a trader should consider when choosing the best trading strategy for them.
Identify goals: Whether you want to explore the possibility of generating profits, hedge long investment positions, or just challenge yourself, hone in on your goals and pick a strategy you think could help you get there.
Assess risk tolerance: Evaluate your risk tolerance and choose a strategy with a suitable level of risk. For example, if you are more risk-averse, you could consider a strategy with lower leverage and smaller position sizes.
Understand your chosen markets: Think about which market you would like to trade in and ensure that your selected strategy aligns well with this market. For example, a strategy that allows you to trade stocks may not be so well-suited to trading commodities.
Backtest the strategy: Before committing to a strategy, it may be useful to test it on historical market data to assess how your trade would have performed. This can help you determine its effectiveness and make any necessary adjustments.
Monitor and adapt: Once you have settled on a strategy that works for you, keep a close eye on the markets and your performance, and be willing to adapt if market conditions change or your results don’t meet expectations.
With that out of the way, let’s look at some CFD trading strategy examples.
Day trading is one of the most common methods of trading in pretty much any sort of asset class or financial instrument. The trade is started at the beginning of the day and finished at the end of the day, not leaving the positions open overnight.
Technical analysis tools can be useful in ascertaining whether or not there is a likelihood the asset will go down or up. Although traders should keep in mind that past performance is not a guarantee of future results.
Traders may want to close their position at a time when they have either seen a profit they are happy with or a loss they can handle. Stop-loss orders, ordinary or guaranteed (which require a fee), and take-profit orders can be used to automate the closing of the positions. Day trading is usually used for short-term trading.
With swing trading, traders aim to find a possible price trend and then hold an asset for a period of time – from a minimum of one day to several weeks – in an attempt to make a profit.
Again, this strategy will need the markets monitored and technical analysis made. Swing trading is so called because it is based on waiting for price changes, or swings. Swing trading is used as a medium-term strategy.
Position trading, also known as Trend trading, is a CFD trading strategy in which a trader holds on to a CFD for a longer period of time and closes the position when the time is right. This involves monitoring an asset’s performance, and also requires patience and, in many cases, paying holding fees.
A potential disadvantage of this holding an open position for long periods is having to pay overnight fees. Position trading is seen as a more long-term strategy.
This strategy is based on keeping an eye on breaking news in the financial world and using that knowledge to predict markets’ likely moves and inform trading decisions.
It can include looking at economic and corporate reporting calendars; positive company quarterly financial statements may boost the stock up, while a disappointing balance sheet can hurt the price. Similarly, positive or negative economic readings and central banks’ announcements may shape investor sentiment.
Fundamental analysis can help traders learn more about how financial news may influence asset prices.
When it comes to trading, a CFD strategy some people like to use is hedging. In this case, CFDs are used to mitigate against potential losses from holding underlying assets.
Let’s say a trader owns shares in a company, but the latest quarterly report shows disappointing financial results. Theoretically, they could take out a short position on a CFD in the company’s shares so that even if the value of the stock goes down they can potentially mitigate losses by profiting from the short CFD trade.
However, if the asset does not perform in the expected manner, the trader could end up losing even more money than they otherwise would have.
With swing trading, traders aim to find a possible price trend and then hold an asset for a period of time – from a minimum of one day to several weeks – in an attempt to make a profit.
Again, this strategy will need the markets monitored and technical analysis made. Swing trading is so called because it is based on waiting for price changes, or swings.
When utilising any of these strategies it’s important to proceed with caution. Make sure you do your own careful research. Remember, markets can move against you at any time, and you must never be liable to lose more money than you can afford. Also keep in mind that the past performance of an asset does not guarantee future returns.
If you keep those three principles as a benchmark, you can spend your time working out a CFD trading strategy that works best for you.
The best strategy for CFD trading would be based on individual trader’s preferences and goals, knowledge of and experience with various markets.
CFD trading can be rather complex and requires practice, knowledge of a particular market and an understanding of leverage and margin trading. This also means it can be risky, and arguably not suitable for beginners.
People lose money when trading CFDs when the market moves against their position. This may be due to a number of factors: unexpected market volatility and shift of sentiment, or lack of thorough research by a trader.
Markets can be highly volatile, and even experienced traders can find themselves at the mercy of an unexpected movement, regardless of the CFD trading strategy they employ.
The main disadvantage of CFD trading is the heightened risk when leverage, or borrowed money, is used to trade in CFDs. If you do so, and the trade goes against you, you risk losing more money than you put in.
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