The number of contract for difference (CFD) trades has grown substantially over the past few years as this relative newcomer to the markets has widened its appeal to many different types of investors and speculators. This popular form of derivative trading differs from older established and so-called ‘mature’ products such as options and futures in some important ways, but essentially the scope and fast pace of the world of CFD trading are the elements that are contributing to its huge growth in popularity.
As CFD trading covers so many global financial markets, including traditional stocks and shares, forex, indices, commodities and much more, it offers a 24/7 environment that can make use of any market or exchange around the world operating at any time of day.
Basic principles
CFD traders take a position on future price movements of a particular asset which is never actually bought, sold or owned in the trade. As such, it is a form of derivative trading based on the value fluctuations of what is known as the ‘underlying asset’. As this can take the form of a variety of different markets, this allows CFD trades to utilize international exchanges in a way that no other form of trading can really compete with.
Also, taking a short or long position allows short term changes in prices to be successfully exploited, meaning that a fast turnaround can be achieved in a highly flexible ‘day trading’ style environment.
Spotting opportunities
Research is a fundamental element in success for any form of investment or market trade, so understanding CFD trading basics is key. The next step is to know how to spot the right opportunities to take a position and make a CFD trade, so choosing the correct market at the right time is a skill that needs to be cultivated and developed.
There are various strategies that successful CFD traders use to find new opportunities. These range from complex data interpretation systems such as technical and fundamental analysis which use charts built up over different periods of time, through to the so-called ‘news strategy’ which entails paying close attention to breaking stories and headlines related to a chosen market. Each approach aims to spot trends and repeating behaviors that indicate which direction the price of a particular asset or market will move towards.
Using leverage
As a financial instrument that uses trading margins, leverage can be used to take a position within CFD trades. This means that much larger sums can be put into the equation without having to provide it as a capital amount upfront. Different brokers will offer competitive margin ratios, but it is essential to take a measured and sensible approach in this area.
Leverage has its downside as losses can grow quickly, especially in some fast-moving markets that are favored by many CFD traders such as forex. This means that having a well thought out risk management strategy is vital for successful trading. Any opportunity that looks good on paper can turn sour, so knowing how to use stop-loss orders to place a limit on potential downturns is another essential aspect that must be learned and put into action.
On the other hand, take-profit orders are also frequently made available. These allow traders to lock in profits if a position rises to a certain level. Both stop-loss and take-profit orders allow traders to separate themselves from the emotional aspect of making a decision on the spot.
Essentially, these limiting orders can be put in place on a CFD trading position and allow an automatic end to the trade to be activated if a certain level of loss is encountered. When using leverage as a trading tool it is foolhardy not to make the most of the safety net that these simple, yet effective, instruments make available.
Trading strategy
When you know enough about the basics to actually become active in trades, having an overarching strategy in place is another essential aspect that leads to making the most of CFD opportunities. This does not just mean knowing the best and worst case scenarios for levels to set stop-loss orders to fit your investment funding, it covers the entirety of how and why certain trades are chosen in which markets and what positions are taken.
For instance, anyone who uses technical analysis will be drawn towards assets that provide accurate and reliable data sets over certain time frames. This means that those markets which are covered by official reports on a regular basis may end up being favored. Likewise, someone who leans towards a news-based trading strategy might be more likely to make decisions and take positions that depend on breaking headlines or critical events.
Personal involvement
Whereas many investors who dabble in stocks and shares are often of the ‘buy and forget’ mentality and may even defer the responsibility for choosing assets to a third party, most CFD traders prefer a DIY approach that puts them firmly in control and makes the most of the fast-moving markets available to them. This means that there is a significant element of personal involvement in finding and using good CFD opportunities.
Staying focused and making sure that emotion does not play a part in positions taken and assets chosen is a big part of successful CFD trading, as is the realization that incremental gains can add up to a big win rather than simply looking for that jackpot trade to come along.
Choosing a reliable CFD broker is also key to making the most of the opportunities on offer, as this can really make a difference. It is not just a question of fees and costs, as different platforms will also have advantages and disadvantages and the amount and quality of information made available will obviously determine how potentially good trades can be spotted and moved on quickly enough.