Contract for Difference (CFD) trading has risen to the position where it is now a prominent way of trading on one or more of the global financial markets. In a nutshell, it is a short- to medium-term, high-risk, high-reward method of investing in the financial markets without having to fork out substantial amounts of money to purchase the underlying shares.
What is a Contract for Difference?
Before we look at several simple tips to trade successfully using the CFD investment vehicle, let’s have a quick look at a succinct definition of a CFD:
As a Jones Mutual financial advisor notes, “a Contract for Difference is a legal contract that is signed between a brokerage and an investor.” It is a leveraged product that is designed to take advantage of an underlying asset’s price movements without having to purchase shares in the underlying asset.
Advice for the beginner CFD trader.
As we have stated previously, it is a high-risk investment vehicle. Therefore, it is absolutely vital to have an intimate understanding of what a CFD is, how it is structured, and how to leverage it to increase your wealth portfolio.
Here are several tips to help you advance from a beginner to expert CFD trader:
Trade small amounts.
When you first start trading it is not a good idea to place trades using significant amounts of money. There is lots of time to learn the CFD trading nuances. Also, everyone makes mistakes, so it’s important to take things slowly. Also, when trading on a leveraged product, you can lose more than your initial deposit. Therefore, until you have gained experience with CFD trading, it’s vital to place small trades.
Avoid impulse trading.
Impulsive or emotional trading can be a recipe for disaster. You might get lucky and guess a couple of times correctly; however, the risk of losing more than your initial deposit when trading using emotions is too high. Therefore, it is vital to have a logical, research-based reason for opening and closing a specific trading position. The only way to determine when and what to trade, is to research both the underlying asset and the general market conditions thoroughly.
Stick to what you know.
While you are gaining experience trading CFDs, it is vital to open and close CFD trading positions on underlying assets that you know and understand. If you diversify too soon into sectors that you do not have an intimate knowledge of, you will unnecessarily increase your exposure to risk.
Reduce your exposure to risk through diversification.
It is essential to implement different strategies to reduce your exposure to risk. A straightforward way to lower your risk is to diversify your investments. For example, you can trade CFDs with a wide variety of underlying assets and asset groups like Forex, stocks, and indices. Therefore, if you only invested in mining stocks and the mining sector prices are down, then you run the risk of losing your entire investment. You can reduce this exposure to risk by investing in mining stocks as well as assets in other categories.
Entrance and exit trading levels.
Before placing a trade, it’s vital to decide when to enter and exit the trade during your research phase. Secondly, it is equally important to ensure that you exercise self-discipline and wait for the underlying asset’s price to reach your opening levels. Furthermore, it is essential to decide on more than one exit point; one for when the price movement goes against you, and one when the price movement continues to move in the way that you predetermined.
Letting your profits run.
Not only is it important to know when to open and close your trading positions to maximise profitability, but it is also equally important to know when to extend a trade to increase your profit levels. For example, under normal circumstances, you might open and close a trading position at a certain level because you have determined that the underlying asset price will continue increasing past your predetermined level. Therefore, it is a good idea not to get out of the trade and let it the trade run to allow your profits to increase.