Contracts For Difference (CFDs) are an ideal financial instrument that can be used to profit from any one of the global financial market’s asset’s volatile price movements. They are essentially a short-term trading instrument; however, they can also be used to place long-term trades.
At the outset of this article, it is vital to note that CFD trading is considered a high-risk trading activity. And, while this should not chase you away from utilising this financial instrument to increase your wealth portfolio, it is vital to ensure that you use employ risk-free (or low-risk) trading strategies. Unfortunately, there is no such thing as a “risk-free trading strategy.” There are tactics which you can use to decrease your investment’s exposure to risk.
As the following quotation by John Paulson notes: “Stock market[s] go up or down, and you can’t adjust your portfolio based on the whims of the market, so you have to have a strategy in a position and stay true to that strategy and not pay attention to noise that could surround any particular investment.” In other words, implementing the right trading strategy and sticking to it is the essence of successful online trading.
Before we look at several solid CFD trading strategies (especially for beginners), let’s look at a succinct definition of a Contract for Difference.
Essentially, a Contract for Difference is a legally-binding contract between a trader and a broker. Its main aim is to leverage the price movements of an underlying asset without having to purchase large volumes of the linked asset.
The trader enters into the contract when he opens a trade. At this point, the opening and closing asset prices are specified as well as whether the trader believes the asset’s price will rise or fall.
When the trade closes, the contract expires, and the broker or the trader pays the other party the difference between the opening and closing prices. If the price moves in the direction that the trader specifies, the broker pays the trader the difference between the opening and closing amounts and vice versa.
One of the first things that a beginner trader must learn is not to trade on emotions. This is very difficult especially when you notice that one of your trades is making a loss. In this case, it’s natural to panic and close the trade without thinking. The first important factor to remember is that CFD trading leverages an asset’s volatile price movements to make a profit. Thus, the asset’s price will change direction often. Therefore, to avoid trading on emotions, it’s vital to choose your trading strategy and stick to it no matter which way the asset’s price moves.
2. Add stop-loss and take-profit values to each trade
The stop-loss order is one of the primary tools that can be used to reduce your investment’s exposure to risk. Thus, every time you open a trading position, it’s essential to add a stop-loss value to the trade. The stop-loss calculation is typically the maximum amount that you can afford to lose on each trade.
The take-profit point, on the other hand, has the opposite effect to the stop-loss indicator. Succinctly stated, it is the point at which you choose to exit the trade. It is important to note, however, that it is equally important to add a take-profit value to each trade. This figure will automatically close the trade at a pre-defined point; thereby, preventing the trade from making a loss should the price swing in the opposite direction. Again, the simplest way to determine the take-profit value is to work out what percentage of profit you would like to make on each trade.
3. Let trades run for as long as possible
Additionally, it’s vital to let each trade run for as long as possible to derive maximum profit without the price swinging in the opposite direction and making a loss instead of a profit.
There are also more complex ways of working out the stop-loss and take-profit points like determining at which point it is no longer beneficial to keep your trading position open. This can be worked out using trading signals and by looking at a number of technical indicators like the RSI (Relative Strength Indicator) and the Bollinger Bands indicator.
Setting up a prosperous trade is a balancing act between setting the right stop-loss and take-profit values. And, probably the only way to get this balance right is to keep on practising.