A Contract for Difference (CFD) is a leveraged, derivative financial product that creates agreements for trading between two parties (typically the individual making the position and a reputable broker).
The aim is to trade the difference in price movement of an underlying asset’s value between position entry and exit. Leveraging with CFDs allows traders to get into the market with little collateral and place higher stakes, and can be utilised in a host of financial markets, like forex, commodities, indices and shares.
Benefits and risks
As CFDs are leveraged at their core, traders can take up more significant positions without the full financial commitment. In fact, many brokers often only require 5% of the position’s price. This means that you can make more use of the capital you have available by spreading it across positions.
Undertaking CFD trading isn’t advised for beginners, as trading strategies can be complex and the market is typically volatile. However, with some experience and the right tools, larger profits can be made, especially when compared to other trading products.
CFD brokers are also required to follow rules and regulations set out by the FCA. More information on this can be found here.
There are plenty of benefits to CFD trading and this is why it has grown in popularity in recent years. You can expect:
- Diverse market options and vehicles
- Fewer shorting rules
- Fewer day trading regulations and entry requirements
- Trade on both rising and falling markets
As with any form of trading, there are risks involved. For CFDs in particular, traders should be aware that while trading on margin makes for higher profit potential, it also increases the chances of significant losses (and these may even exceed your initial deposit). Many individuals get caught out with their contract’s total exposure, so this is something worth keeping in mind.
To help mitigate yourself from risk, ensure you carry out effective research into the markets and or companies you’re looking to trade in. When you’re ready to trade, utilise stop losses to protect yourself from significant unexpected losses.
Advanced CFD trading strategies
For many, the pros far outweigh the cons, but risk management will be an integral part of all trading endeavours. Without an effective strategy in place, the potential risks become more sizeable and the more advanced the plan of action is, the better the outcome. It can be important to select one that aligns with your preferred trading style and strengths, but also one that considers your financial capabilities. Here are 3 advanced trading strategies:
1. Contrarian Strategy
The contrarian strategy focuses on the timing of trades based on the predicted movement of current market trends. Essentially, traders will resist prevailing sentiment and take the opposite position to their peers by buying when they sell and selling when they buy. Many trading strategies (and traders with less experience) will often go along with trends, but as the environment can be volatile, predicting shifts and staying one step ahead of the game may give you a competitive edge.
2. Pair trading
One of the top ways to see any kind of success when trading is to minimise risk, and this is where a pair trading strategy comes in. Traders open two opposing positions in related assets (typically opening both long and short positions on one weak commodity and one strong one) to diversify their potential and take advantage of rising and falling market conditions at once. This can ensure profits either way, by exploiting the relationship between the two positions instead of that of the wider market.
Hedging is one of the more advanced CFD trading strategies out there and is better suited to traders who have an existing, diversified portfolio that focuses on long-term endeavours. There are many stock options out there that may experience drops from time to time, yet ultimately hold their value. In these cases, those who are confident in the strength of their asset’s potential over time may not want to miss out on the short-term money-making potential as the market shifts. Hedging allows for short positions to be made without losing long-term assets.
CFD trading is considered to be advanced in its own right, so implementing the right strategies for your needs will be imperative to the success of your endeavours. When the right one is found, it should be strictly adhered to for maximum benefits. As CFDs combine elements of leveraged trading and margins, the opportunities are attractive, but there are risks that need to be assessed before deciding to get involved. Learn more about CFD trading to increase your potential.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.
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