A Guide to CFD Trading Strategies

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Success in trading, and any other similar venture, requires a well-researched and – if possible – a tested action plan. CFD trading is not an exception. This type of trading is generally regarded as complex because CFD assets are highly volatile and carry huge risks. That, however, has not discouraged investors from giving it a shot. On the contrary, it is becoming more popular and lucrative.

As a new or experienced trader, where do you start? Well, do not worry, we have your back. We will guide you on CFD trading, its benefits, and the risks involved. In addition, we will also discuss the best CFD trading strategies that will significantly increase your chances of making profits.

What Are CFDs and CFD Trading?

What Are CFDs

Consider yourself lucky if you know about CFD trading. However, first, if you don’t, you need to know what and how to go about the activity. So, to refresh our memories and ensure we are on the same page, let’s first understand what CFD trading is. 

CFD stands for Contracts for Difference. It is a contract between a buyer (trader) and a seller (broker) and involves a derivative product. Here, the buyer does not own the underlying asset but only speculates on its price movement. Thus, your profit or loss is the difference in the value of the opening and closing price of the underlying asset. 

Simply put, CFD trading means the buyer who is the trader gets into an agreement with the seller who is the broker. This agreement allows you to speculate on either the rising or falling prices of an asset. The contract is valid during the period of entering the contract and closing it. And that will determine the profit or loss. The seller makes a profit when they are paid the price difference by a broker and loses when they owe or pay the broker the price difference. 

CFD Trading Strategies

As mentioned earlier, CFD trading success depends on the strategy adopted. Avoid trading blindly and conduct thorough research on an asset to create the best approach. Good trading strategies increase your trading confidence. Subsequently, it increases your chances of making profits while keeping your losses to the minimum. An effective plan will guide you on when to invest and close a trade and the risks involved.

As a newbie or a seasoned trader, you must know the best CFD trading strategy to maximise your potential. Below we discuss the most popular CFD trading strategies to help you get started in this venture.

1. CFD News Trading

short-term CFD trading strategy

Trading the news is an example of a short-term CFD trading strategy. It involves staying abreast with the market expectations for the near future as a result of economic announcements. Such announcements bring temporary mispricing of an asset. 

Traders take advantage of the mispricing before the market factors it in. Strong decision-making skills and quick judgment is required to tap on such potential trading opportunities. You can use the following CFD day trading strategies with news trading;

  • CFD day trading (intraday trading). Your intention here is to try and make profits from small but frequent price movements. All open positions must, however, be closed within the day.
  • Scalping. It is a super short-term day trading. The trader opens and closes positions within seconds or even minutes. So you end up taking advantage of the small price fluctuations.

You need to have a mastery of the financial and economic calendars to succeed with news trading. Major financial events and factors that affect an underlying asset of interest should be at your fingertips.

You have a choice of either investing before the market receives the news or after. To trade beforehand, you need quality information. Additionally, a thorough understanding of the impact of the news once it hits the market is also vital. Take advantage of such news before it impacts the prices of the assets.

With credible information, you have an increased chance of reaping big. Unfortunately, you should also prepare for the worst-case scenarios. Bad news can negatively affect the market and vice versa, leading to massive losses. You also have a choice of trading once the information hits the market. Therefore, you should be swift as prices change rapidly.

Example:

You can use forex CFD trading strategies to be up to date on information on currency pairs. This information can cause significant volatility in the market—for example, news on the 2016 poll for Britain to exit the European Union. Traders could take advantage of the GBP price fluctuations likely to be caused by such a vote. From your analysis, you could predict that the vote will cause a fall in the value of the GBP.

You then take a short CFD position and sell an instrument. More citizens voted for the exit. The unexpected news caused a fall of GBP’S value against other currencies making your prediction correct. The more the value falls, the more the profit you make. You, however, need to be careful as the market reactions can change after the news release.

2. Pair Trading

Pair trading helps you avoid the risk of exposure. It involves investing in two different CFD positions in the same industry-a short position and a long position for the other. A measure of the relationship of the two assets known as correlation is critical in this strategy. The main aim is to maximize the divergence in the underlying asset prices.

Your interest is not a profit in both positions. All you need is a profit in one position that exceeds the potential loss of the other. Analyze the market for irregular trends between two stocks, which is an indication of a weakening correlation. Take advantage of the divergence by opening a long position for the weaker company and a short position for the stronger one.

You profit from the difference between the two asset prices. One position will be winning while the other losing. The market direction ultimately does not affect your results. 

3. CFD Hedging

CFD hedging strategy

Traders compare hedging to insurance, where you protect yourself from the loss of an asset. The strategy helps traders offset risks within their trading portfolios. A trader aims at eliminating or reducing losses in another investment.

A trader opens a hedge position in a financial instrument to cover up unstable prices in another open position.

Example:

A trader has a portfolio with companies W, X, Y, and Z. You anticipate from an analysis that company Z’s shares will be weakening. You counter this by opening a short CFD position on company Z to cover the losses from the fall in stock price. Thus, despite still holding company Z’s shares in your portfolio, you have protected yourself from the loss of exposure.

Hedging helps a trader take advantage of price volatility hence protecting traditional investments. Price volatility is short-term. The thought of selling your shares and buying them when the market stabilizes might hit you. However, broker costs are involved making CFDs a cheaper and more flexible option when market conditions become unpredictable. 

4. Risk Management Tools

Trading is about risks and returns. Successful CFD trading requires a sound risk management strategy to help keep losses under control. Risk management is among the best CFD trading strategies for beginners. As a novice CFD trader, you need to keep a close eye on the trading risks. It helps mitigate losses in case the trade goes as unexpected. 

Make use of the stop-loss and take-profit orders to manage your trading risks. A stop-loss order is a control that stipulates the extent that you are willing to take up risks. The trade will stop once you attain a specific price, preventing further losses. It is helpful in case of a CFD position drop without your watch.

The other tool is a take profit order which is similar in principle but opposite in application to the stop-loss. It specifies the exact price you would want to close a position and bag the profits. Once you attain the price, the position will be closed automatically.

5. Money Management

money management in CFD trading

The main goal of investing is to make money. Therefore, use the primary rule of money management, which is to save whenever an opportunity arises. In addition, we advise traders to use trading strategies that will not require them to pay for overnight trading positions. Intraday/day trading, swing trading, and scalping come in handy in achieving this. They are also excellent CFD trading techniques for beginners.

To succeed in CFD trading, you need a regulated broker with a wide variety of tradable assets. Most importantly, prioritize the safety of your funds. CFD brokers charge a range of fees and commissions, including minimum deposits, transaction costs, commissions or spreads, market data fees, overnight charges, etc. 

Settle on a broker with reasonable charges while at the same time meeting your trading needs. Additionally, focus on capital preservation. Avoid risky strategies when starting, be ambitious once you gain experience, and remember to budget for every dollar.

6. Control Your Leverage

Leverage is when you gain exposure to the financial market with a smaller upfront capital. It involves depositing a percentage of your full trade value and gaining wider exposure. Thus, CFD trading comes with the benefit of accessing high levels of leverage. Unfortunately, this is also a double-edged sword. A loss in such a trade translates to losing far more than your initial investment. You have to pay for the borrowed funds.

The more you take up leverage in your CFD trade, the more you take up risks. It is vital to use CFD leverage wisely. Unexpected price changes might lead to magnified losses with devastating results. Trade with minimum leverage or no leverage at all, especially if you are new to CFD trading. Increase leverage as you gain experience.

7. CFD Position Trading

CFD position trading

Position trading is a buy-and-hold approach. Here, traders hold positions for a long duration of time spanning from months to years. Traders focus on the long-term market trends and overall movement, ignoring minor price actions.

CFD traders using this strategy rely on fundamental analysis indicators such as macroeconomic trends and historical price patterns.

Example:

Let’s assume a trader who buys CFD units at 275 USD of Tesco plc stock. He thinks that the stock prices will rise over time, Tesco plc being a bluechip company. So in the next nine months, Tesco plc trades at 330 USD. If the trader is happy with the amount, he would close the position and bag the profit. In this case, 55 USD.

Traders using this strategy do not have to apply technical analysis or monitor price charts frequently. Instead, he needs to do occasional company analysis to check if the stock is still on track. The trader can achieve this by P/E ratio calculations, forward earning, and dividends analysis from the company’s financial reports. 

Keep in mind that overnight CFD positions incur holding costs. So you need to factor this in when you choose to go with this strategy.

8. Learn From Your Trades

The past often shapes the future. Keep a trading journal where you record all the open and closed trades. Explain the reasons for entering and exiting the market. In addition, state whether you followed your trading plan and, if not, why?

Use the trading history to better prepare for future trades. For example, from the journal, a trader would quickly identify patterns hence streamlining the trading plan. In addition, the journal will guide you on the mistakes made earlier, leading to more intelligent and faster decisions. 

Traders who don’t keep a trading journal spend a lot of time figuring out where they went wrong. Record any information that you feel is important and relevant to your CFD trading activities. It might seem time-consuming but it is advantageous in the long term.

9. Technical Analysis Trading

 Technical Analysis Trading

The strategy involves studying the available historical data and using them with other indicators to make analytical predictions. 

It is beneficial for traders to set up indicators to help with the technical analysis. Set support levels equal to established lows and resistance levels equal to established highs. In addition, use trend lines to show increasing or decreasing trends in the market. Finally, use the oscillator, which is an indicator that shows the overbought or oversold conditions. It can be an indication that change is about to happen.

10. Swing Trading

CFDs swing strategy involves identifying markets that are trending in a specific direction. Traders take advantage of assets that have the potential to move with a reasonable amount within a short period. The strategy works hand in hand with technical analysis that indicates strong trends in the market. 

Conclusion

Every trader would want to make profits on CFD trading. Unfortunately, we are not immune to losses as trading is about gains and losses. CFD trading has been stereotyped as a complex trade with high possibilities of losses. We strongly dispute this position as statistics indicate that it is slowly becoming popular with new and experienced investors. 

Success in CFD trading depends on the strategy adopted, hence a critical step in the trading journey. Mastery of an effective plan will be a significant advantage to you, and practice will eventually make it perfect. So, make use of the risk-free demo accounts provided by brokers to build knowledge and experience. Then, develop and stick to a trading plan to meet optimal returns.

All said and done, we are hopeful that you find the guide helpful. With it, you are on the right track to becoming a successful CFD trader. 

Thadeus Geodfrey
Thadeus Geodfrey

is a copywriter with extensive experience in trading. Thadeus knows exactly his field and what he writes about. His goal is to make life easier for traders and provide them with important information about brokers. Now, he continues to be active in trading and researching brokers for you.

There is no need to doubt his experience because the guides Thadeus writes speak for themselves. He knows exactly what to draw your attention to and will tell you truthfully about each trading platform.

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