Contracts for Difference (CFD) have gained in popularity as a new and less capital-intensive way to trade stocks, indices, currency pairs and commodities in today’s financial markets.
The compelling benefit of cfd trading is that you do not have to buy the underlying asset at its full face value. By using leverage or margin offered by your broker, you can purchase a position in the market at a much smaller value, yet still reap the full benefit of its subsequent move in the market, as if you had followed the traditional investment route. There are other benefits, as well, including the ability to short the market without restrictions or shift suddenly to indices when the general market moves suddenly in a new direction. Pricing is typically included in the Bid/Ask spread, such that scalping strategies may not apply.
Although leverage can greatly increase your chances for profit, it can also magnify your losses. At the end of the day, trading in CFDs does not that differ that much from trading in other market mediums. You still need to have a disciplined approach and a detailed step-by-step plan for achieving your goals.
You can win with CFD trading, especially if you follow the guidance of the ten suggestions detailed below. Likewise, you can also lose and lose big time, if you do not pay attention to the pitfalls in this arena. For that reason, we have also included a companion piece to this article that speaks to what to avoid. Read about the pitfalls of cfd trading. Adequate preparation starts with awareness, and, although many of these suggestions may be familiar to you or just plain common sense, they bear repeating, if only to forewarn you.
1) Know Thyself and What You Want: Not everyone is cut out to be a trader, but if you have the will, stamina, and nerve to try risky things, then CFD trading may offer a good avenue for you. Are you a newcomer to training? Trading in any form is a high-risk activity, not suited for raw beginners. Training, education, and practice trading are a must before dabbling in any market. As you gain experience with this art form, you will begin to learn more about yourself and how you react under pressure. Risking real money is fraught with anxiety, and your ability to deal with stress will be revealed. After self-examining your objectives and your tolerance for risk, you will be in better position to assess logically how to proceed. Without this self-awareness step, it would be easy to rush headlong into CFDs, guided by your emotions alone, which can easily be a recipe for disaster. Choose a timeframe that is consistent with your needs and stick to asset choices that are familiar to you.
2) Knowledge is Power: CFD brokers offer a broad range of trading opportunities, but you will have a better chance at winning if you stick to what you know. If you have traded currency pairs with leverage, then you have a basis to build upon, without the tendency to commit early mistakes on unfamiliar ground. If you want to venture into stocks, indices, or commodities, then perform a little more research before diving in. Leverage or margin, along with stop-loss orders may act differently due to gapping and frequent market openings and closings. Use fundamental analysis to give you an alert for a particular forex pair or asset type, and let technical analysis guide your entry and exit. Conditional orders can be set to buy on strength to preserve a good entry. Study how your favorite choices have reacted in the past, what patterns and setups occur frequently, and if seasonality plays a part in supply and demand dynamics. Get comfortable first before venturing outside your comfort zone.
3) Risk Management Rules are Important: Mitigating market risk is about knowing your risk/reward expectation before you enter a position. Money management rules are part of this discipline to enable you to weather bad losing spells so that you can recover and get back on a winning streak. If you are prepared to lose $200 on a single trade, then your prudent account balance would be between $7,000 and $10,000. When market forces are moving strongly in your favor, you may consider increasing your position size to strike while the iron is hot. An active trader will also limit his open positions to three at the most. With CFDs, the need to monitor positions is greater, since major swings on the margin can easily wipe out your capital at risk, if you are not careful. Learn to accept losses as a necessary component of any trading activity. Your goal is to record “net” gains over losses, but losing streaks do happen, even to veterans.
4) Practice, Practice, Practice: Practicing on a demo system can be boring, but you are more apt to pat yourself on the back for winning trades, than to learn from your mistakes, the real reason that practice sessions are invaluable. Veteran traders swear by their practice routines, claiming to have spent as many as three months or more before trying out their strategies with real cash. Practice sessions are also meant to steel your nerves against emotional intervention, the most prominent reason for early casualties. Your goal will be to develop a step-by-step routine that will guide your decision-making and block your emotions from interfering. Some veterans purport to having “Post-Its” stuck to their computer screens to keep their minds focused and uncluttered. Impatience and Greed are your enemies. Learn how to contain both, and you will be on your way to consistent net gains over time.
5) Patience, Patience, Patience: Trading is not about how fast or how many trades you can put on the books in a short period of time, but idle hands and minds can definitely lead to mischief. Your goal is to maintain a 60/40 split of wins over losses, as measured in currency value, not by number of trades. This point is key. Poor traders typically have a number of wins and losses that cancel each other out, but then a few large valued losses that destroy them. Veterans are able to achieve the opposite by killing losing trades early, and by waiting patiently for major trending moves to firm up. You can achieve the right ratios by consistently waiting out the market for those two or three times during the month when the opportunity for a large gain presents itself. Learn to be patient with winning trades and impatient with losing ones. If you have to be active in the market, then practice on your demo system.
6) Diversify Your Risk: CFD brokers tend to offer anywhere from sixty to over two hundred asset choices. The temptation to experiment in multiple markets is great, but try not to put all your eggs in one basket. For example, if you have several positions with energy-related assets, they all may move in tandem, both up, as well as down. To avoid this type of “sector” risk, it is prudent to diversify into other areas to buffer any major swings that might happen unexpectedly. One benefit of CFD trading is that you can quickly switch strategies if the overall market suddenly trends in one direction. When the market moves in this way, it is time buy a position in an appropriate index and then to ride the wave for as long as it lasts.
7) The Trend is Your Friend: Winning at the trading game with CFDs is no different than anywhere else – You must tilt the odds in your favor and have confidence that your trading plan is sound and giving you the “edge” you need. Veterans gave up betting on bottoms and tops long ago, and trading range-bound asset choices can be difficult with CFDs due to expanded Bid/Ask spreads. The odds then favor finding trends, after confirmation by indicators. Markets may only trend 30% of the time, but when they do, momentum is on your side. Strong moves will typically over shoot the mark, thereby providing another opportunity when the reversal occurs. Once again, patience is the key. As always, preparation precedes success, or as some have said, chance favors only the prepared mind. It is always recommended to buy into strength, and short into weakness. Do not “fight the tape”. Choose your setups, based on experience, and then follow your plan for consistent wins.
8) Cut Your Losses and Let Your Profits Run: You will find that it is easy to open positions, but closing them is where the rubber meets the road. If you are to win at this game, you must learn to pull the trigger on losing trades. Yes, you want to give a trade a chance by setting a stop loss that allows them to breathe, so to speak, but never drop a stop loss to let it breathe more, and never ever add more money to a losing trade in hopes of a quicker way to recover your losses. These scenarios are exactly how CFDs can wipe out your account balance in the blink of an eye. On the other hand, letting your profits run may sound easy enough, but cutting off a winning trade can also destroy your goal for consistent “net” gains over time. Impatience is the problem. The odds favor a trend continuing, such that employing a trailing stop may provide a solution worth trying to correct bailing out too early.
9) Monitor Your Results: If you are only trading high-percentage setups, then you will have time on your hands for monitoring both current and previous situations. The current aspect of this activity will depend on the trading timeframe that you have selected. Do you wish to close out each day in order to avoid overnight charges? Is your trading horizon over a few days such that minor fluctuations are not cause for concern? The issue is that a leveraged investment position is at a higher risk due to market swings. Margin calls can happen more frequently with CFDs due to the low capital entry requirement. You need to be aware of when a margin call might be imminent. Do not forget that a price-gapping episode might render your stop loss order null and void. Secondly, veterans always maintain a journal of their trades. Weekend preparation is then consumed with understanding why failures occurred and why winning trades happened. Get into this healthy habit to benefit from knowing your weaknesses, as well as your strengths.
10) There is Always Another Opportunity around the Corner: Are you beating yourself up for closing a winner too early or allowing a loser to run longer than it should have? Did you miss a big run up in a security or currency pair that everyone else seems to have noticed? Do not give up. These situations happen to all of us, even to professionals. The typical response of the inexperienced trader is to increase the pressure to jump back into the market, but hold on! Calm down. Every veteran knows that there is always another opportunity just around the corner. If you missed out on one ride, another will soon appear. Do you see how “Patience” is the constant watchword of a successful trader? Study your mistakes, and learn from them. The more preparation, the better! Act in line with your plan, and enjoy the effort!