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CFD Trading Strategies for 2023
Almost every website that allows a person to trade in CFDs comes with a warning printed on it, by the order of basically every governmental jurisdiction that will work with them: “Most people who trade CFDs lose money in their first year. Trade with caution.” This can be a chilling warning for some.
It can also be old news for those who decided to give it a try. CFDs are risky. Lots of people lose money on them, and it is somewhat expected that they do. All investing has a learning curve. It does not matter whether you’re talking about basic stock trading or advanced foreign currency juggling.
There are a few things that make CFDs uniquely difficult to trade, however. Today, we are going to talk about what those things are. Of course, we will define what CFDs are first, just in case you don’t know.
Even if you do know, you might find there are details that have slipped through your notice.
Finally, we will talk about the strategies that you need to employ in order to make money trading CFDs. By the end of the day, you will have an idea of where to get started in trading CFDs.
Table of Contents:
- What are CFDs
- What is Special About CFDs
- What are the Disadvantages of CFD Trading
- The Main CFD Trading Strategies
- Where to Trade CFDs
- Which is the Best CFD Trading Strategy for Beginners
What are CFDs? 🤔️
To begin with, CFDs are a type of financial instrument. It is an acronym that means “Contract for Differences”. Part of what makes them so interesting is the fact that they do not involve the trade of any underlying asset. You are not buying a stock with a CFD. And yet, CFDs are linked to the stock market.
How is that? Well, let’s look at the words involved in “contract for differences”. To begin with, CFDs are a contract between a buyer and a seller. You, the consumer, will almost always be the buyer, while a broker of CFDs will be the seller. The contract between you two requires a few things to be completed.
First, Find a Stock
The very first thing it needs is for the buyer and the seller to agree on a stock.
As mentioned before, you are not trading this stock. Neither the buyer nor the seller needs to own it. What they do need is a method of tracking the stock that is impartial and that they can agree upon. For instance, you might use Google Finance, Yahoo Finance, Marketwatch, or some other third-party tracking service. This will give you an unbiased report of the stock’s price at any given time.
Truth be told, you do not necessarily need to agree upon a method of tracking the stock. It is not obligated by many contracts. But for reasons that are about to become clear, it is ideal that you do, and even if it is not part of the contract, you should keep track of the stock’s price anyways.
Second, Note the Current Price and Name a Future Price
Once a stock is named in the contract (and a method of tracking that stock is secured), the buyer and seller will agree upon two things. The first is the “current” price of the stock at the time of the contract. The word “current” is in quotes because this price can be the price at the time the contract is finalised, or it can be the average price of the latest trading day. It might also be the final price of that trading day.
It is important that a CFD trader knows exactly what the current price of the stock is, as well as how that price is decided upon. If a broker seems to be imprecise in how they determine what the current price is, then that is a red flag. As you will see, they profit off of your potential failure.
After the contract is finalised, the “current price” will be called the “original price”. This is where you pay for the contract for differences. The initial purchase of the contract will include paying for a commission fee, as well as paying for the contract in the amount of the original price of the stock.
Last, the Buyer Names a Date and Waits
After all that is set up, the buyer just needs to name a date in the future. The date is the “expiration date”, after which the buyer can no longer take any profits from the contract. While some brokers will let a buyer choose their own date, others will set limits on how far in the future the dates can be, though most will just set a date in the future automatically no matter what the contract is like.
It is worth noting that at this point, a broker might have you state whether or not your position is “long” or “short”. A long position is a position wherein you expect the price of the underlying stock of the contract for differences to go up. A short position is the opposite: You expect it to go down.
Not every broker requires this, but whether you end up with a long position or a short position can have an impact on the cost of the contract, as well as the expiration date. Most importantly, however, is that the difference between long and short will massively impact what kind of money you make.
The Impact of Long vs. Short
So, a long position means you expect a stock to go down, while a short position means you expect it to go up. But how do those expectations impact your contract? Or the money you end up making?
Well, by declaring whether you go long or short, you declare “I will take profits this way, or that way.”
You make money through contracts for differences through the difference between the original price and the price at the time you end the contract (or when the contract expires if you don’t end it manually). If you take a long position, you only make money if the price is higher than the original price.
That means if the price of the underlying stock is lower than the original price, you will lose money.
Conversely, if you take a short position, you only make money if the price of the stock is lower than the original price. This is why the original price of the stock is so important to establish and track. Some shady brokers might try to “find” the price of the stock through some esoteric calculation while you’re expecting the stock to be the price as it is listed on the Australian Securities Exchange.
Let’s Look at an Example
Now that we have the three parts of a contract for differences, let’s walk through how it would work.
You approach your broker with $11,000. You establish 100 contracts with them for Widget Industrial. Each share of Widget Industrial costs $100. You pay for the 100 contracts, costing you $10,000 in total, and then pay about $100 in a standard commission fee for the transaction.
If your broker is the type to ask if you are going long or short, this is when they will do it. Most brokers will assume a long position by default. Those that offer a choice will charge a fee for taking a long position, though even the brokers that only offer long positions will include this fee at times.
Once you’ve paid for this contract, you can end the contract at any time, or wait for it to expire. When it does, you receive a payment in accordance with the difference of the underlying stock. As we said before, if you went long and the price increased, you make money equal to the increase.
That means if you buy a contract for 100 shares of Widget Industrial at $100 a share and it goes up $10 per share, you can close the contract with a $1,000 profit (because that $10 gain is multiplied by the 100 contracts you have). And of course, if you took a short position, you would instead lose $1,000.
What is Special About CFDs? ➡️
We have established what CFDs are and how they work. But you might have noticed something interesting. If buying 100 contracts of Widget Industrial costs $100 per contract due to Widget Industrial’s stock price being $100 per share… How different is that from just buying the stock?
There is a world of difference, and those differences are what make CFDs so unique. To begin with, you do not need to actually own the stock (or even be able to access the stock) to profit off of it.
You can Short Any Stock Easily
The process of “shorting” a stock can be complex and reliant on certain brokerages and hedge funds allowing for the borrowing, buying, and selling of a stock. But CFDs allow you to take up short positions even when the stock is not being loaned out by anyone. That means you can short anything.
This is particularly valuable during periods of high market volatility, as we will cover later.
You Don’t Need to Worry About Normal Trade Limitations
Lots of trading platforms obey a rule they inherit from doing business in the United States. This is called the “Pattern Day Trader” rule, and it states that no one with less than $25,000 of capital can day trade both instantly and as much as they want. CFDs do not involve the transfer of stocks though, meaning that they do not fall under the purview of this rule.
They Follow Their Own Schedule
If you are trading on the Australian Securities Exchange, the hours that you can trade run from 10:00 AM to 4:00 PM Sydney time. For some people that is not opportune. If you have a job that takes up your attention for those hours, then you can be open to losing money to volatility while you’re busy.
In short, despite its difficulty, CFDs are actually more accessible to many traders in a lot of ways. You can trade however you want, whenever you want, at any time you want.
What are the Disadvantages of CFD Trading? ❌️
While we can talk up CFD trading all day, we cannot act like it is without drawbacks. CFD trading comes with serious risks that amount to convincing reasons to avoid it, or at least be careful with it.
Here are a few:
The Rules are Inconsistent ✖️
You might have already noticed this based on the number of conditional statements we put into our description of how CFDs work. Things like whether or not you can choose long positions or short positions, the ability for a broker to scam you, and other risks are all issues with the security.
Part of the reason for this inconsistency is the fact that so many of the rules of CFDs are not written down anywhere. But why is that? Simple:
Regulations are Light ✖️
Most countries in the world will only have one regulation on CFDs, and that is either allowing them or disallowing them. There are no set rules as to what the contracts contain, like there are with stocks.
In fact, despite the similarities CFDs have with gambling, there are not even rules to protect consumers against CFDs with terrible odds. And because CFDs are so obscure, many consumers are unaware of the protections that they do have related to the securities, rendering them vulnerable to scammers.
If a scammer does something like misrepresent a CFD to a consumer, they can really only be charged for it if they represented the CFD as a security other than a CFD. Surprisingly, that actually happens.
Scammers are Everywhere ✖️
It is worth noting that some of the biggest CFD traders in the world—managers of a huge American hedge fund—were convicted for securities fraud while selling CFDs. Their precise crime is that they were basically selling CFDs to people who did not know what CFDs were and lying about how they worked.
They also used their position in the hedge fund to manipulate the price of low-cap stocks. That means they offered CFDs to people, and then cheated to make those people lose money to them.
None of this is to say that you should avoid trading CFDs, of course. But if you are not aware of the risks involved with the lack of rules around CFDs—to say nothing of the money you can lose even if you know the rules perfectly well—then you are practically asking scammers to take your money.
The Main CFD Trading Strategies 💡️
With all that out of the way, let’s talk trading strategy. Because CFDs are deliberately similar to stocks, the core trading principles of CFDs are similar to stocks as well. But their small differences, even the fact that they are different in name only, changes how you approach them.
There are five different trading strategies we will go over today, each one either the same or at least similar to strategies that are regularly used in stock trading. Because of that, we will divide them into two categories: The first is trading strategies that match up with stock trading, while the second is trading strategies that are totally unique to CFD trading.
CFD Strategies that are Similar to Stock Trading ➡️
1. Two Hour Trading
We mentioned earlier how many people are restricted from day trading by rules set on securities exchanges all over the world. While this limitation is ultimately arbitrary, there has been a trading strategy built around it that a lot of people have made a lot of money off of: Two-hour trading.
The idea here is that you buy your stocks (or contracts, in this case) in the last hour of one trading day, and then sell them in the first hour of the next day. Obviously, this gets around any day trading restrictions a market might have on its customers below certain amounts of capital. But it is also proven to be a great time to make money, with trading between these two hours yielding high returns.
You see, many day traders, algorithms, and retail traders will only have the interest, programming, or opportunity to trade during these first and last hours. That means that these hours will have the most swings of any time during the day, ensuring that if there is a positive swing, it will be large.
At the same time, waiting a day before selling can allow certain problems in the market to be “priced in” by the market. Interest rate changes and jobless claims have had a big impact on stock markets this year, but those changes have rarely been unpredictable for more than a day.
As a result, buying at the end of one day will usually result in positive trends being carried over (as the ultimate fact that everyone wants to make money always carries over) while negative trends are not carried over as they are generally shorter-lived.
If there is one problem with this strategy, it is that it relies upon the broker offering your contract for differences to allow you to close your contract at will. About half of all brokers will let you do this, while the others will either make you stick to a pre-assigned date, or make you wait two weeks to close.
Of course, if you are allowed to choose your own date, then all you have to do is choose the next day. But all the same, two-hour trading is such a consistent way to make money that some brokers try to work language into their contracts that either forbid it or hamstring it.
2. Day Trading
There is a bit of mythology around day trading due to its potential for both absurd upside and downside potential. This is even more the case with CFDs, where the lack of material tie to stocks means that you could, theoretically, day trade as fast as you can move your fingers to execute the contracts.
But the act of buying and selling a position within the same day is only part of the day trading process. The real strategy behind day trading is the technical analysis that enables a person to both predict and respond to shifts and reversals in the market. These can include chart analysis methods that recognise patterns in the price action of stocks, as well as responding to moves in the world around stocks.
Any CFD broker that allows for two-hour trading is definitely going to allow for day trading. If you have the money, the time, and the knowledge, then you could stand to earn a lot from day trading.
But if you lack money, time, or knowledge, day trading is a short path to losing all your money. The thing about day trading is that it opens you up to lots of risks that you might not know exist.
Consider leverage. The best way to describe leverage is “putting all your eggs in one basket”. If you have $10,000 to invest and you invest all $10,000 of it into the same industry, then it does not take much downside from that industry to hurt your bottom line. That is called being “over leveraged”.
Even if you make many small, low-risk trades while day trading, you have a good chance of overleveraging yourself over even just a day. This is why many traders who make 20 trades per day will end up with worse gains than traders that make two trades a day or less.
Be extremely careful when you are day trading, as it is a shortcut to pain.
3. Short Hedging
In any stock market in the world, you will find a type of stocks called “inverse leveraged” stocks. These are stocks that are tied to a specific stock. And rather than going up and down due to their own virtues, these stocks change their price based on the price of the stock to which they are tied. If the stock goes down, the inverse leveraged stock goes up, and vice versa.
A popular method of either hedging your bets or day trading in the stock market is to alternate between buying and selling a stock and its inverse leveraged counterpart. Therefore, no matter which direction the stock goes, you are making money. But not every stock has an inverse leveraged counterpart.
That is where CFDs come in. Since you can take up a short position on CFDs, you can create your own inverse leveraged stock. This means that with a little planning, a good understanding of a certain stock, and a lot of quick manoeuvring, you can make money whether a stock is going up or down.
On the flip side, this method is also used to mitigate risks. If you are not sure which way a stock will go, you can buy the stock and establish a short CFD at the same price. That way, if (or when) it goes up, you sell the stock. If (or when) it goes down, you close the CFD. You might even do both on the same day.
This is an incredibly high-maintenance style of trading, meaning that it is like day trading with extra steps. It is also the most complex, meaning that you can very easily lose money just by creating a “dead zone” between your long position on stocks and your short position on CFDs.
Basically, imagine that you buy stocks at $100 and can only get short CFDs of the same stock for $95. That creates a $5 dead zone where you are losing money on both. This will likely break eventually, but “eventually” means you have to wait, and waiting is a death sentence for many traders’ mentality.
Only attempt this strategy if you have a lot of knowledge and are comfortable with the swings in value it can create. Committing to a $500 gain sounds exciting until you are one button press away from executing it and realise that it also opens you to a $1,000 loss.
Strategies Dissimilar from Stock Trading ➡️
4. Non-Stock Trading
While most CFDs (and CFD brokers) will deal in stocks and nothing else, many also deal in commodities, foreign currencies, and even things like options, futures, and bonds. The significance of this means that you do not have to be an expert in stock trading in order to profit off of CFD trading (though expertise helps). Moreover, it also means that you can make trades that are insulated from the stock market.
One of the things that makes the stock market in general unique from things like commodities is that while the stock market respects the laws of supply and demand like commodities do, consumer sentiment and general human will have much more sway over the stock market than commodities.
If the CEO of Widget Industrial makes a lofty promise or shows interest in another company, then those words can cause an upset in the stock market even if there’s no action to back them up. That promise might be totally empty and meaningless. But if enough people believe it, that promise is money.
Contrast the commodities market. Imagine a farmer says they are thinking of harvesting more crops this year. All someone has to do is ask that farmer if they planted enough crops earlier to get such a harvest, and to prove it. If the farmer can’t prove it right there, their commodity’s price doesn’t change.
Words are wind when it comes to the commodities market, and that means that highly unpredictable elements like consumer sentiment and corporate grandstanding do not impact their prices.
Of course, a lack of volatility will also drive people away from markets. If we are being completely honest, volatility can make people a lot of money. Capitalizing off of volatility is risky, and it takes a lot of time, effort, and knowledge to really get anything out of that risk.
But if you spend too long in a market that feels like it’s trading flat, then the tiny returns over long amounts of time will feel mind-numbing and like a waste of time. This is especially true with CFDs.
Not many brokers even trade CFDs for things other than stocks. And those that do will always trade CFDs for stocks alongside them. Safe bets are nice, but it is hard to feel like they are worth it when you could be making thousands with the same contracts, especially since you can lose money on commodities anyways.
While one might consider CFD trading of currency to be similar to CFD trading for commodities, the reality is that currency is so complex that it is a completely different beast unto itself. Why?
Well, to begin with, currencies will often have both stocks that track their value and inverse leveraged stocks that track the opposite of their value at the same time. This is on top of the foreign currency pairs that a forex trader would normally trade. This means that one currency can have half a dozen instruments related to it. How are you supposed to navigate all of that?
The answer is, as ever: With great care. You are unlikely to need to make use of every single financial instrument related to a currency. In fact, less is more when it comes to the ways you trade a currency.
What is most important is that you know about what is impacting the currency, how it is impacting it, and that you are able to responsively trade your CFDs relative to that. If that means shorting the inverse leveraged stock of a foreign currency rather than just shorting the foreign currency, then go for it.
You might have already noticed, but this is easily the most complex of all the trading strategies out there. The number of optimizations you can make during the day might make you nauseous. But on top of that, foreign currency’s interaction with the stock market means that it is subject to the same empty promises that the stock market can be moved by. In short, you need to be careful.
Trading foreign currency CFDs also means, as you might have guessed, learning about the foreign currency trade. That is a whole other bag of worms for you to open on your own before getting into this kind of trading, as we are choosing to focus on CFDs right at this moment.
The bottom line is that the more you know about a foreign currency to begin with, the better time you will have making use of its CFDs. Trading CFDs is the last thing you should do if you are new to the foreign currency world. The only exception of this is if you are planning to only trade CFDs of the stocks and inverse leveraged stocks that tie themselves to those foreign currencies.
Where to Trade CFDs? 📊️
After you figure out what you are trading and how you are trading it, the next step is finding a good place where the trading can actually take place. There are tons of CFD brokers in the world, and due to the lack of regulation on CFDs, they can do business in international markets as well as domestic ones.
Most CFD brokers will be offshoots of existing trading platforms. That means they will also trade stocks and other securities and utilise a website or phone app to help facilitate your trades. These trading platforms are the place to go for CFD trading. But there are so many. How do you pick which to use?
Since there are so many, we won’t bother going over each and every one. Instead, we will give you the tools to find the best and safest CFD traders yourself. That way you can make a choice that works for you, rather than having an opinion handed to you when that opinion might not benefit you.
Let’s quickly go over three criteria by which you can measure the value of a CFD market.
1. The Security of the Contract 🔒️
You don’t need an education in contract law to spot a bad contract, but you might need one in order to spot a really good contract. The main component of a good contract is that it gets specific.
That means it doesn’t just have a blank to fill in for a stock and its price. It also has a space to fill in what method will be used to track that stock’s price. You won’t just enter the ticker code for the stock, but the market it is traded on. The more it asks of you, the more certain you can be that it is airtight.
And remember, a tight contract is good for you as well. The tech industry has jaded many people to the idea of a long contract. But outside end user license agreements for software, longer contracts tend to add up to more protection, not less.
2. Beware of Scammers 🕵️
There are few easy ways to tell if a CFD broker is a scammer. First, see if they deal in any other securities. If they deal in stocks, foreign currency, commodities, or bonds, then they have to be managed by some kind of overriding governmental authority. It might not be your government, but there are worse things than being managed by the United Kingdom’s regulations rather than Australia’s.
It also helps to look at how old they are. If a broker is less than two years old, then that is a red flag even if everything else is in place. You can never be too careful, and choosing a broker is not like choosing between Amazon and a local bookstore: Buying local means nothing.
Lastly, be watchful of any broker that has strong incentives to join their platform and spend money on it. If joining and spending gets you entered into contests or promises you cashback rewards, then the broker is no better than an online casino.
3. Look Out for Crypto 💰️
This advice cuts both ways. CFDs for crypto exist, and lots of people make money off of them. If you have knowledge of crypto or interest in it, then you might want to seek out a CFD broker that works in cryptocurrency CFDs. But if you have neither knowledge nor interest, then avoid crypto entirely.
Why? Like CFDs, crypto lacks strong regulation. That means if a CFD broker trades nothing but CFDs and cryptocurrency, there is a lot of room for that broker to be a scammer. Of course, there are plenty of CFD brokers that trade crypto alongside things like stocks and bonds, which makes them more appealing.
Which is the Best CFD Trading Strategy for Beginners? 👀️
If you are just starting out with CFDs, then the best way to go is the first strategy we mentioned: Two-Hour Trading. Indeed, it is quite similar to normal stock trading, making some people antsy to do something that is more CFD-exclusive. But the beauty of it is that you don’t have to do it exactly the same as you would if you were trading stocks if you don’t want to.
Two-hour trading is done because people can’t buy and then sell on the same day. It is a good strategy aside from that limitation, but once you start trading CFDs, you leave that limitation behind. If a two-hour trade won’t work for you, or if you need to cut your losses, you can leave it on the same day.
The beauty of CFDs is that they are so versatile. They can essentially act as a focal point for all the trading that someone does. You can reap money from stocks, commodities, crypto, and a ton of other types of securities without being limited by scarcity, markups, or other extractive forces.
There are risks, no one will deny that. And every website that trades them comes with a warning that most people lose money trading CFDs. But most people lose money trading no matter what they trade. If you have the stomach for it, learning CFDs can be an opportunity for you unlike any other.
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