CFD tradingis a derivative investment that allows you to speculate on either the falling or rising of global financial markets. That means you get to speculate on the falling and rising of commodities, indices, currencies, shares, and treasuries.
Depending on your position of speculation, you can then either make a profit or a loss. In essence, if you think the prices of a certain instrument, say currency will go down, you can sell or go short. Alternatively, if you think the prices of that instrument will go up, then you can buy or go long.
To enjoy a successful CFD trading experience; there are four key steps you need to observe.
1. Select The Market You Are Most Comfortable With
As noted above, with CFD trading you can speculate on a variety of instruments. The first step is therefore to select the market that you are comfortable enough with and that you can speculate on with high percentage of accuracy.
If you are more knowledgeable of currency, then go for currency. If you are more knowledgeable in shares, then go with shares.
In the same vein, it also means that you pick a broker who allows a myriad of trading cfds. If for instance, you prefer the indices market, but your broker does not offer that market, then you put yourself at a disadvantage.
2. Determine If You Will Go Long or Go Short
Arguably, the most important decision. The first thing to note is that because the CFD market is dependent on if the market will rise or fall; CFDs are often quoted in two prices—the bid price and the offer price.
The bid price is lower, and the offer price is higher. Therefore, if you think the market price of the underlying asset will fall, then you sell at the bid price. In contrast, if you think the market price of the underlying asset will rise, then you buy at the offer price.
With that in mind, and after careful analysis, you can now determine if you prefer to go long or short.
Consider this example of trading an index CFD to help you understand going long and short. A given index quote is 5802-5803. Thinking that the index will rise, you go long and buy at 5803. Unfortunately, things go awry, and the index falls to 5783-5784.
Therefore, you exit the trade by selling at the bid price of 5783. So,
Opening = 5803
Closing = 5783
The loss in points = 20
Because 1 CFD equals 1 pound for every point, then your loss is 20 pounds.
3. Set a Stop and Limit Order
After deciding if you will go long or short, the next step is risk management. Risk management is a way of ensuring you can exit a trade before too much damage is done if things do not go your way as seen in the example above.
That means you set a stop loss order that will automatically close a trade if the market fluctuates to a certain level. In the example above, if the trader had set a stop loss order of 5793-5794, then it means they would only have lost 10 pounds as opposed to 20 pounds.
A limit order, on the other hand, is an instruction that directs the platform to close a trade if the market actually rose and you have already made a profit. It is a way of locking in profits to ensure that in case the market falls again, you’d already closed the trade at the right time.
4. Monitor and Close Your Trade at The Appropriate Time
With risk management set, you can now monitor the fluctuations of the underlying asset and close the trade if you feel you have made a significant profit or you want to avoid a significant loss.
As with any trading experience, CFD trading is full of risk. However, following the above steps will ensure you minimise loss and maximise profits.