‘Top 3’ CFD Trading Strategies
CFD trading strategies often are very similar to the tactics adopted by those that invest in more traditional instruments such as equities. That being said, they do provide a number of benefits or advantages that give traders more flexibility and exposure to large profits seeing as these financial products are traded with leverage. In the CFD trading article we posted the other week, we outlined how this derivative gives traders the benefits of trading market movements without actually owning the financial instrument. This article however, delves into the specifics of certain types of strategies.
1. A Hedging Strategy
This is the lowest risk profile strategy, as by definition ,it is designed to completely remove risk. When people hear the term ‘hedging’ they immediately switch off. “That’s some financial jargon i’ll never understand, why should I bother learning about it now?” Does this sound familiar? Hedging is not a difficult concept to understand at all. Think of it simply as an insurance policy. When someone is looking to hedge all they are doing in practice is protecting themselves against a negative event. This doesn’t stop a bad event from occurring, it just minimises your risk of loss or damage should that circumstance eventuate.
In the world of finance traders, fund managers, banks and large financial corporations use hedging strategies to minimise their exposure to risks such as market risk and investment risk. What they do is essentially offset the chance of losses arising when markets move in the opposite direction to their predictions. To counter this, they take up a position in a secondary market that is the direct opposite to that of their positions in the primary market, limiting their losses. Financial markets can become highly volatile and traders, especially in FX or CFDs markets always look to protect their holdings from devastating movements in price. Perhaps the most common of CFD trading strategies is that of hedging. This is used to prevent future losses and balancing asset exposure. As mentioned above, hedging CFD trading strategies are enacted when opposite positions in associated markets are taken up. They are more directly set up when buying and selling the same instrument too.
When Would I Use This CFD Trading Strategy?
Hedging CFD trading strategies are usually used in two main circumstances. The first is when protecting your profits and the second is to ensure you are well prepared for uncertainty or volatility.
2. Trading The World’s Markets
While not quite qualifying as CFD trading strategies, one of the real benefits of trading CFDs is the fact that it allows traders exposure to hundreds of different markets from derivatives to stocks. If you’ve spent some time trading shares you’ll know all too well how difficult it is trading equities on foreign markets. If you’re based in Australia and want to trade American shares, often a foreign trading account is required to be set up. This is not so straight forward, especially if you don’t have a bank account set up in that country. If you’re a trader that relies on trading on margin too, its often quite difficult to get enough leverage in foreign equities markets to make a decent profit. This is where trading CFDs comes in as you can easily trade overseas markets through your local CFD broker at leverage levels you’re accustomed to trading at.
Are there any brokerage or exchange fees associated with trading CFDs?
No. Zero exchange or local brokerage fees exist with foreign equities CFD trading strategies. If you’re a UK trader you also won’t have to pay Capital Gains Tax either as UK tax law maintains you never actually own the underlying asset.
3. Pairs Trading Strategies
When trading with CFDs traders can create basic trading strategies and also more advances ones. An example of a more advanced strategy is pairs trading which involves trying to benefit from the difference in price between two similar assets within the same industry. This type of strategy is also commonly called statistical arbitrage or a market neutral strategy. It occurs when a trader buys one instrument and at the same time sells another and is called pairs trading because traders are essentially just trading a pair of CFDs. Therefore, this CFD trading strategy includes taking a long and a short position at the same time in say, similar shares. While utilising this strategy you’re getting the benefit of the leverage that CFDs provide meaning your gains are much more significant than your initial outlay. The benefit of it though, is that you don’t really care which way the markets move especially if you pick a closely aligned pair of shares. This is why pairs trading is also called a neutral market strategy and it utilised during times of volatility or uncertainty.
What are some good examples of equities used for pairs trading?
Any shares in companies whereby these companies operate in the same industry such as BHP and Rio Tinto or Commonwealth Bank and Westpac.
Other CFD Trading Strategies
Other CFD trading strategies of note include swing trading and news trading. Traders should always stay abreast of market and economic news as it has the power to influence the prices of financial instruments. This particular strategy is not unique to the trading of CFDs which is why we didn’t go into it in depth. Swing trading is about taking advantage of small corrections or swings in asset prices within the wider market’s trend, either bear or bull. However, this is risky as it’s incredibly difficult to spot a swing point. This strategy is also not unique to CFDs.
A Summary of CFD Trading Strategies
If you’ve made it this far down the page, you’ll no doubt realise that CFD trading requires a lot of research and hard work. It is not something that can be picked up over night. The most successful derivatives traders are diligent and have spent years learning the intricacies and vagaries of global markets. To put things in context for you, the CFDs trading strategies discussed here are just the tip of the iceberg with hundreds more existing out there. While there are significant risks associated with CFDs trading or anywhere where significant leverage levels are at play, for those prepared to put in the hard yards, long-term profitable trading awaits but please be cautious.