What is a CFD?
A CFD – which stands for Contract for Difference – is a financial derivative product that allows one to speculate on a variety of global markets such as shares, indices, forex and commodities without actually having ownership of the underlying asset. The contract allows for settlement of the difference in price between the opening and closing trades. CFDs have proven to be hugely popular, and their use has expanded exponentially since their introduction in London in the 1990s as an equity swap that was traded on margin.
Traders who anticipate an increase in price will buy the CFD, while those expecting a decline in price of the underlying asset will sell an opening position. CFDs can also be used to trade futures contracts such as those crude oil and corn. These standardized contracts have obligations to buy or sell an asset at a predetermined price with a future expiration date.
What is a CFD trading strategy?
A CFD trading strategy is an established plan for buying and selling derivative instruments with the goal of making a profit. The rate of return on the investment will be determined by a few factors such as speculations for which trades to make, when to enter or exit a position, and how much capital should be risked on each position.
To make sound investment decisions, stockbrokers carry out fundamental and technical analysis to research and forecast price trends of the securities in the future. Effective use of CFD trading strategies will reduce the vulnerability of losing all the capital. A trading strategy is chosen by finding a preferred time frame, the desired position size, and the number of trades one is looking to open.
Rules to follow in CFD trading
Use stop loss orders – once a trader enters a position in the market, one can initiate additional orders to control the risk. This is known as a stop loss order. The trader can also indicate where they wish to exit a trade with a profit. This is known as a take profit order.
Use a demo account first – most new investors lose money because of lack of practice and proper experience. Familiarising oneself to the trading field to improve the necessary trading skills will enable one to manage the risk, and secure the invested capital. Once the trader has accurately identified the use of all the different functions of a demo account, only then can he move to the real world, and implement their strategies properly. Most CFD trading platforms offer some sort of demo account.
Doing your research – trading with CFDs requires regular reading and knowledge acquisition in the following areas; markets to be traded, global current affairs, politics, etc. The more you know, the better the capacity to make the best possible trading decisions.
Limit Leverage – leveraging is an investment strategy that allows the trader to gain exposure in a financial market with a smaller margin (upfront capital). This can also be referred to as margin trading. Leveraging can be extremely dangerous if not well applied. On the other hand, it can provide real benefits to the trading portfolio. Used well and sparingly, it should help skew the risk/reward ratio to the trader’s favour.
Devise a trading strategy – For a trader at any level of expertise, it is important to develop a method that can easily be replicated because of its simplicity and its success. The strategy should take you from where you are to ideally want to be. This plan should be based on personal objectives, and should answer such questions as what is your budget, what is your experience level, how much time do you have dedicated to trading.
Diversify exposure – for one’s investment to be secure, one needs to split the risk over as many different markets and instruments as possible. Diversification of capital across a number of investments will make sure that even in the worst case scenario, the capital is protected.
Choose a reliable CFD broker – the role of the CFD broker is to provide market prices of the underlying asset through their trading platform. Some characteristics of a top-rated broker would be:
- Reasonable capital requirements
- Variety of CFDs
- Reasonable charges.
Jimmy Norin is a Co-founder of TradingGuide, with more than 10 years of experience in management, web visibility, and investments. He works tirelessly to create the perfect workplace, while ensuring that the team performs like a well-oiled machine.