CFD Trading Strategies
CFD trading strategies, for the most part, mirror those used by traditional stock investors but there are some subtle advantages that allow for additional flexibility and the potential for higher levels of profitability. Through leverage (using a small percentage of initial capital outlay to capture the gains and losses of larger positions) traders can use a wide variety of strategies to increase trading gains in a relatively short period of time. Because of this, it is easy (and preferable) for many traditional stock investors to make the transition to trading CFDs.
Common trading strategies
Next we will look at some of the most commonly implemented CFD trading strategies used by today’s investors. We will discuss long vs short positions, short-term vs long-term positions, swing trading strategies and hedging. CFD trading at its most basic level involves the purchase of one asset and the sale of another. What many people don’t realise is that we are always in some type of financial position, even if we simply choose to leave our money in the bank. If that is the case, you are essentially taking a bet that the currency being held will perform well against other asset classes. You should remember that we are always exposed to the market, to some degree.
CFDs: long vs short
For active investors, the purchase of an asset is commonly referred to as a ‘long position’. This requires an expectation that an asset will gain in value over the life of the investment contract (the CFD). Conversely, a ‘short position’ occurs when an investor ‘sells’ an asset at a certain level, with the intention of buying it back at a later date. A short seller’s expectation is that the price of the asset will fall over the life of the contract. If this assumption is incorrect (and prices actually begin to rise) the trade will accrue losses equal to the difference between the opening and closing prices. More on going long vs going short.
CFDs: short-term vs long-term
The second essential aspect of CFD trading is the timeframe. Short-term trading (sometimes referred to as intraday trading) allows traders to profit from price changes that occur from hour to hour or minute to minute. Most of the common CFD trading strategies can be used by short-term traders, with the advantage that short-term trading allows traders to limit financing costs (which can be more expensive for CFD traders). Conversely, some investors prefer long-term trading because of the higher level of forecasting ability created by the underlying trends governing the market. A long-term CFD trading strategy also allows traders to capture larger price moves, as these trades typically last from a month to a year (or longer).
Swing trading strategy
Swing trading is the attempt to benefit from smaller reversals (or ‘swings’) within larger trends. For example, in bull markets, prices will inevitably experience periods of consolidation or retracement and fall below previous highs. Since the underlying momentum continues to be positive, these periods of retreat could be viewed as buying opportunities on the assumption that prices are most likely to continue in an upward direction.
The reverse would be true in bear markets, where opportunities exist to initiate short positions. The advantage of this trading strategy is that trades are easy to identify and forecast (as trends are easy to spot and tend to continue more often than they reverse). The main disadvantage, however, is that it can be difficult to identify the exact reversal point (that is, when the swing has reached completion).
Hedging: a protective strategy
One counter to all these CFD strategies is hedging, which is a protective tactic as opposed to a strategy designed to achieve new gains. When hedging, traders are already established in open positions and are looking to protect these positions from losing any of their value. Essentially, this is done by taking an opposing position (opening a trade that is inversely correlated to the open position). Since these trades move inversely, one will make gains while the other is making losses and this balance will nullify the overall position bias.
The advantage of this strategy is that your total position is protected and there is no possibility of new losses. The downside is that this removal of risk will also mean there is no possibility of reward, and additional gains will not be seen. Typically, this strategy is implemented during times of extreme volatility where price activity becomes unpredictable and traders want to eliminate the potential risks involved. More on hedging.
Fortunately for investors, CFD trading has been widely researched and time-tested to the point where many of the mistakes commonly made by amateurs can be avoided when trading plans are respected and carried through until completion. There are many different types of strategy, and each of these can be tailored to your individual goals and investment needs. It is important, however, to have a firm understanding of the different strategy options available, so that your trading plans can realise maximum gains.
Here we have discussed buying and selling, investment timeframes, swing trading and hedging but this is by no means a complete list of all possible CFD trading strategies. Additional research will show other investment options but these strategies form the core of the most commonly implemented strategies used in today’s market environment.
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