Did you know you can trade the global markets without having to physically own the assets you trade? Did you also know that you can trade and benefit from downward market moves as well as upward ones? If not, it’s time you learnt about Contracts for Difference, or CFDs for short.
A CFD is a contract between a trader and the broker they trade now, allowing the trader to speculate on the price movements of instruments like forex pairs, indices, commodities, ETFs, individual stocks, and more. Whether the trade ends in profit or loss is determined by the difference between the buy and sell prices of each contract.
Of course, it’s not quite as simple as diving into the markets and opening your first CFD trade. There’s many more steps traders should take in order to first get familiar with the markets. Doing so will help traders begin their trading journey in the right direction.
In this beginner’s guide, we’ll provide jargon-free, easy-to-understand insights into trading CFDs successfully. Any jargon we do use will include the definitions on-hand.
CFD Trading Terms for Newbies
First things first. Aspiring or new CFD traders should get to grips with the basic terminology needed to find your way around the markets. Let’s start.
Margin – the amount required to maintain any existing open trading positions.
Leverage – the ability to control a larger trading position, identified as a ratio. For example, a leverage ratio of 1:100 means that for every $1 you deposit, it’s possible to make 100 times that amount in profits. However, leverage will also magnify potential losses.
Commodity CFDs – Commodity CFDs allows you to trade the underlying value of assets such as gold or oil.
Index CFDs – Index CFDs, or indices, allow you to trade leading stock indices such as the FTSE 100, the Dow 30, the Nasdaq 100, or the S&P 500.
Going long – ‘going long’ in a trade means you to take a buy position on a CFD, allowing you to profit if prices subsequently rise, or take a loss if the price falls.
Going short – ‘going short’ in a CFD trade means you take a sell position on a CFD, allowing you to profit if prices subsequently fall, or lose the trade if the instrument rises.
Equity – the total funds you have in your trading account to invest.
Swap fees – interest charges applied by your CFD broker in order to keep open positions open overnight.
Stop loss – an order that closes your positions if the traded asset’s value falls below a predetermined price level.
Take profit – another order that closes your positions if the traded asset’s value reaches a predetermined profit level.
Slippage – the difference between the price you intended to buy or sell an asset at and the actual price.
Pip – the smallest unit of price movement in forex trading.
Bullish – a type of market sentiment indicating optimism and an expectation of rising prices
Bearish – another type of market sentiment indicating pessimism and an expectation of falling prices.
CFD Trading Tips if You’re Starting Out
1. Use stop losses
Stop-loss orders are the most full-proof way to limit your losses and protect you from getting liquidated – essentially blowing your entire account. Along with drastically improving your risk management, stop losses also mean you don’t have to micromanage your open positions every ten seconds.
2. Practice on a demo before going live
Starting on a demo account lets you familiarise yourself with the trading platform, instruments, and tools available to you from your broker. You’ll also be able to trade with fake funds, usually anywhere from $1,000 to $100,000, which you can use to learn the fundamentals of opening trades, closing them, and learning how the markets work before you dive head-first into real trading.
3. Keep your leverage under control
The greater the leverage you take from your CFD broker, the less breathing space you give yourself. If the market starts to move against you, you’ll have precious little opportunity to close your position without incurring a big loss. Remember that the bigger your leverage, the easier it is to lose your entire account.
4. Have a trading plan
Without a clearly defined trading plan, it’s very easy for CFD trading beginners to steer away from a smart trading approach. If you don’t have a plan in place where you consider what you’re going to trade, when to trade, and how to trade, this can lead to getting yourself involved in trading setups you wouldn’t ordinarily take, essentially making you a headless chicken in the market’s headlights.
5. Keep your emotions in check
Maintaining positive trading psychology is one of the biggest things you need to overcome as a CFD trader. It’s something you’ll need to learn and correct overtime. Emotional decision-making means impulsive actions, which will lead you into trading losses.
Popular strategies for new CFD traders
1. Day trading CFDs
Day trading with CFDs is a popular short-term strategy that involves entering and exiting trades with the aim of closing out the position before the end of the day. This is with the intention to profit from small but consistent price moves. But remember if you choose this approach, trader’s will need to meticulously monitor the charts multiple times each day. You’ll also be paying closer attention to price action and technical analysis rather than fundamental factors.
A day trader usually studies things like support and resistance levels from the previous trading day/week in order to uncover possible reactions that prices may take when it arrives at those identified levels once again. For day traders, it’s also important to keep up with latest retail forex news that can move markets.
2. News-related CFD trading
Another short-term strategy, trading the news involves staying up to date with economic announcements and market expectations for the near future. Due to dealing with stronger market volatility, this strategy is considered a much riskier one. It requires strong decision-making skills and the ability to make quick judgements on potential trading opportunities that arise. It’s a strategy particularly useful for volatile markets that react fast to external factors, such as gold and oil.
3. Hedging with CFDs
The hedging strategy allows traders to offset risk inside their trading portfolio. Some examples of effective hedging strategies include pairs trading and the use of derivatives, such as forward contracts. You can also trade safe haven assets as a hedge. That can include trading gold, government bonds, the USD, and defensive stocks, as this category of instruments are considered less vulnerable to negative market shocks than other instruments that traders prefer in a ‘risk-on’ environment.
4. CFD Position Trading
This trading approach is about long-term thinking. Position traders take an investment-like buy and hold approach. In the case of CFDs, this could also be a sell and hold approach, if you think the market you’re trading will go down in the future. Position traders may hold trades for months or even years, ignoring minor price volatility and focusing on long-term trends. Position CFD traders tend to rely on fundamental analysis over technical, such as macroeconomic trends and historical price patterns.
But with this approach, you need to consider a cost that short-term traders don’t face. That is called swap fees, which is an interest fee charged on positions held overnight. Position traders could get around this by opening a swap-free account, sometimes referred to as an Islamic account too. However, be prepared for higher commissions and trading spreads if you select this account type with your CFD broker.
Traits of successful traders
If you want to grow from a newbie into a successful, long-term CFD trader, there are many things you can learn from already established, successful traders. Here are four common traits that unite the 1% of consistently profitable CFD traders.
They master risk management & trading psychology
You need to accept that trading the markets is an emotive business. Accepting risk and losses is not something the human brain is trained to do. The most successful CFD traders remain level-headed at all times. They do that by using the risk management tools available to them and mastering techniques to limit the effect of emotions and biases when active in the markets. Some of these techniques include journaling, meditation, and imposing limits on their trading.
They learn from common beginner mistakes
Consistently profitable CFD traders take the time and energy to learn from previous mistakes and the mistakes of others. They don’t over-leveraging or over-trade, and they make the conscious effort to only trade within the confines of their trading strategy. They also go back and analyze their winning trades just as much as their losers – a technique known as journaling, which can help traders review past trades and adjust future strategies.
They learn From their own mistakes
Let’s face it. No matter how much preparation you make or knowledge you acquire, when it comes to trading, everyone is bound to make mistakes in the beginning. The most successful traders have more than likely lost money or even previous accounts before becoming consistently profitable. Don’t be too afraid of making mistakes in the beginning. After all, learning from them will be your most valuable lesson in the long-term.
They trade how it suits them
As a beginner CFD trader, you’ll likely come across so-called ‘trading gurus’ and financial influencers on social media, sharing their strategies and trading advice. While some of their information may be useful, you should remember that imitating someone else’s trading strategy letter by letter won’t always bring you the same results in principle. Every successful trader acknowledges that what works for them may not work for others, and as a result, you should adjust every minor detail of your trading strategy and setup to suit yourself. This will mean identifying the assets to trade, analysis methods, platforms, risk to reward ratio, and trading times that make most sense to you.
They follow the news
Traders need to stay ahead of the latest retail forex market trends and updates. Doing this can give you an edge over others, since an understanding of the latest trends can help guide you toward more informed trading decisions.
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