16 April 2024 - 9min Read

Trading strategies

CFD trading strategies

When developing a trading strategy, in addition to the technical aspects, it’s important that you consider your personality, including your tolerance to risk and how you react to both taking losses and booking profits. It’s also vitally important to be clear about how much time you can commit to trading. This will help you decide whether you’re better suited to day trading or something longer-term like trend or swing trading.

Before implementing any strategy, it should be back-tested, as this will help you estimate its downside risk and upside potential. While this is helpful, it is important to note that past performance, which is what is assessed in back-testing, is no guarantee of future results.

CFD (Contract for Difference) trading has become increasingly popular with retail investors over the last decade. But many have struggled to make consistent profits from CFD trading. This article explores some of the pitfalls of CFD trading, as well as some important trading ideas that, we hope,  may boost your success in your trading career.

TABLE OF CONTENTS

Key takeaways

  • A CFD is a financial agreement between two parties, typically a trader and a CFD broker (for example, Trade Nation).
  • It is a contract that pays the difference between the open and closing trades as a settlement. 
  • A CFD trader doesn’t own the underlying asset but rather makes a profit or loss depending on the asset's price fluctuation.
  • CFDs are traded on margin. They provide exposure to the full value of the underlying asset, but a trader only needs to hold a small percentage of this to make a trade.
  • They employ leverage, which magnifies the potential profit or loss.
  • With CFDs, it is also just as easy to speculate on an asset falling in value as it is to speculate on it rising. 
  • CFDs have a spread, that is, the difference between the sell price and the buy price.  This must be considered while placing stop-loss or take-profit orders.
  • Whether you are a day, swing, or trend trader, you can find opportunities in all markets when trading with CFDs due to the ability to go short.

Marc Aucamp

Content Writer

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What are CFDs, and how do they work?

CFDs are derivatives of underlying assets and represent a contract between buyers and sellers. CFDs enable you to benefit from price movements without owning the underlying assets, and no actual share of stock, currency, or commodity is traded. 

Unlike purchasing equities on the stock market, where profits are generally only made when markets are rising, CFDs enable traders to benefit from falling prices.

You can learn more about CFD trading here.

Following from above, investors in stocks tend to employ a buy-and-hold strategy, looking to profit from rising prices. However, you can sell (short) a CFD with the aim of buying it back cheaper if the market declines. CFD trading provides a broad range of opportunities depending on each trader's unique market expectations in both rising and falling markets.

What CFDs can you trade?

We offer CFDs on the following markets:

Forex: You can trade CFDs on forex majors, exotics, and other crosses, with varying levels of liquidity and volatility. 

Stocks: You can trade CFDs on a large selection of individual stocks and many global stock indices.

Commodities:  You can trade CFDs on energy commodities such as US WTI Light Crude Oil and UK Brent Crude Oil. We also offer CFDs on gold,  silver and a range of industrial metals. 

You can download the complete list of instruments with their specifications here.

CFDs trading strategies

Here are some of the most popular CFD trading strategies.

News trading

News trading on CFDs involves monitoring the economic and financial calendar. This will alert you to  upcoming news events in the financial world that may influence the behaviour of the financial markets  on which CFDs are based.  

There are two basic news trading strategies: trading before or after a data release. 

With the first option, the trader is trying to forecast two things: will the data release be above or below the consensus expectation? And secondly, how will the market react to anything unexpected?  Both factors are exceedingly difficult to predict, so trading in this manner is highly speculative and not recommended.

The second approach is to trade after the news or data have been released. The assumption is that the market will react in a predictable manner. Unfortunately, this isn’t always the case. On top of that, there may be an initial movement in the way you predicted, which then turns sharply before you have had an opportunity to close out your position.  If you do decide to trade this way, then it is critical to use stop loss and take profit orders to help safeguard your money.

Trading with technical analysis

Many CFD trading strategies rely on technical analysis. Technical analysis entails evaluating historical data on charts and looking for patterns. Technical traders look at price charts to help predict the future direction of the asset's price. They will use different time frames to hone in on price behaviour, and then overlay price charts with technical indicators such as the MACD and RSI. They also use drawing tools to identify areas of support and resistance, and trend channels. 

Hedging

Hedging can be considered as a form of insurance. Hedging is generally employed by investors who  already have a diversified portfolio of stocks that they  intend to retain for the long term. If an investor is concerned that the stock market is due for a correction, but doesn't want the effort and cost of closing down their portfolio, then they can construct a hedge through CFDs. If they have a diverse portfolio, then they may sell CFDs on a broad-based stock index. If their risk is concentrated in a few stocks, then they could sell CFDs against these specific holdings.  

Assume you own shares in Apple stock. You feel that the industry is faltering and that stock prices will decline. But you don't want to sell your shares since you trust in them in the long run. Instead, you go short on Apple stock using a CFD. You will gain from the stock's short-term decline without losing the asset, or suffering the cost of closing out the position, and without any tax implications that may ensue.

Day trading

Intraday trading is a common short-term approach that entails opening and closing a trade before the end of the day. A day trade may be held open for a few minutes or a few hours. The idea is to benefit from small but frequent price changes. However, day trading requires you to watch prices and charts closely, which involves a lot of time spent concentrating on the screen.  Day traders generally employ technical analysis rather than focusing on fundamental variables affecting a financial instrument.

You can learn more about day trading here.

Swing trading

Areas of support and resistance are important to swing traders. They feel most at home when a market is stuck in a range, but they can also find opportunities in trending markets too.  Unlike trend traders, swing traders are comfortable shorting into an uptrend, or buying into a downtrend, just as long as they can identify significant areas of support and resistance where they can set stops and book profits. Swing trading involves holding a position anywhere from a few days to a few weeks.

You can learn more about swing trading here.

Position trading

Position trading, or buy-and-hold,  involves holding a position and ignoring any short-term market volatility with the expectation of achieving a substantial gain over a more extended period. Depending on the underlying security, this may need some fundamental analysis as well as technical analysis to find decent entry and exit levels. 

CFDs aren’t necessarily the best financial instrument for position trading. Most position traders find stocks to buy and hold. They are most likely to build up a stock portfolio paid for in full, rather than being held on margin. However, as explained above, buy-and-hold investors often employ CFDs as a tax-efficient method of hedging a portfolio.

Advantages of CFD trading

CFDs have several key benefits.

  • You can go long or short.
  • Leverage is available, and this can range from  1:10 to 1:500, depending on the instrument and the regulatory jurisdiction. Consequently,  you can start CFD trading with a relatively small deposit. 
  •  The costs of trading CFDs are relatively low when compared to buying and holding physical assets.
  • CFD brokers should be regulated by government regulatory authorities and abide by the laws which are there to protect the customer.

Disadvantages of CFD trading

CFD trading, like any other, has certain risks. 

  • You can lose money quickly by incorrectly forecasting the market’s direction or by over-trading  your account.  Some traders also lose money by failing to employ a stop loss. 
  • You can also lose money when your emotions get in the way of your decision-making process. So-called ‘revenge trading’ or the urge to recover losses, along with trading due to FOMO (fear of missing out), are traps that are easy to fall into when trading CFDs. 
  • Leverage is a double-edged sword. It increases both your profit potential and your risk of taking a loss. 

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Final thoughts

CFDs are complex financial derivatives, so it’s important to carry out some study and due diligence before trading them actively.  Employing the proper strategies will be critical to your success. This is particularly important as CFD trading is done on margin and therefore employs leverage. This means that selling or going short of a market is just as easy as going long. It also means that both profits and losses are magnified. Before opening and trading on a live account, learn more about CFD trading to improve your chances of success.


People also asked

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There is no single "best strategy" for CFD trading, as all trading depends to a great extent on each trader's personality, objectives, and risk management.

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CFDs are sophisticated financial instruments that carry a significant risk of loss. As a consequence, you should apply risk-management techniques to reduce this risk as much as possible.

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Long-term CFD trading may be accomplished by using a position trading strategy. However, it is worth noting that the majority of CFD trades are opened and closed within 6 months.

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CFD trading is potentially risky due to leverage and margin trading. Another aspect of it is non-regulated brokers, which you should avoid.

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Yes, CFD trading can be profitable. However, just like any other skill, it requires time and effort to learn about the product and the markets.

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