CFD or Contracts for Difference trading has become a very popular and successful investment vehicle over the last couple of years. Suffice to say, it is increasing in popularity as we speak and stands to gain further traction in the global financial market trading space.
CFD Trading: A succinct definition
Before we look at why CFD trading is so popular, let’s take a look at the definition of a CFD to help gain an understanding of why CFD trading is so attractive to both small traders and institutional investors:
A CFD is a contract between an investor and an online financial trading broker. This contract allows traders to trade on the price movements of an underlying asset. Once the contract expires, the difference between the asset’s opening and closing prices is paid by one of the parties to the other party.
The reason why CFDs are so popular is because they use margin and leverage to trade on assets such as Forex, cryptocurrencies, commodities, and stocks. It is not necessary for the trader to invest large sums of money purchasing the underlying asset.
It should be noted at this juncture that CFDs are ideal short-term trading instruments. However, they are high-risk financial instruments as they take advantage of an individual asset’s daily price volatility. Thus, to mitigate the risk, CFD trading should be conducted with wisdom and knowledge.
The volatile nature of different underlying asset classes
Once you have decided to trade in CFDs, the next step is to determine what your exposure to risk appetite is. For example, if you would like to increase your initial investment very quickly, and you are happy to with an extreme risk level, the best asset class to trade on is one that includes assets with a high price volatility such as cryptocurrencies or Forex. The general recommendation in this instance is to start out investing in Forex currency pairs.
On the other hand, if you are keen to keep your risk levels as low as possible, it’s best to trade in CFDs with a low exposure to risk such as stocks and bonds. The reason why these asset classes are low risk assets (relatively speaking) is that they are not subject to extremely high price volatility in a single trading day. Therefore, in this case, it makes sense to start out with CFD stock trading.
CFD stock trading strategies
There are many different CFD trading strategies available for traders of all levels (from beginner to expert) to use. Here are several of the more common strategies:
Day trading is defined as the opening and closing of a trading position within a single trading day. Trades are not left open overnight as they can be exposed to unknown negative price movements. Although, it should be noted that the lower the price volatility, the lower the risk of leaving trades open overnight.
Succinctly stated, swing trading is when trades are left open for several days at a time. The trader aims to profit from the overall increase in an underlying asset’s price, so trades are allowed to ride out the price volatility.
This trading strategy requires patience. It is not easy to ignore the asset’s small price movements especially when they are moving against your trading position.
One of the ways to protect your open trading positions from losing money is to hedge your open trades. In other words, you aim to protect your open trades from losing their value. Practically, this means that you open a trade that is a direct juxtaposition of the trade that you which to protect. Ergo, the each of the inverse trades will move in the opposite direction; one increasing in value and the other decreasing in value. Thus, your overall investment will be protected.
In summary, the most salient point of any financial marketing trading article is espoused in the following quotation by Yvan Byeajee: “Reaching any goal in trading requires specific domain knowledge and technical skills. But then, after that, it’s all mindset management. Yet most people ignore that —they automatically think they have that last part all figured out, and it’s a mistake.”
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