CFD trading strategies you should know

Below, we explore four different CFD trading strategies that will help your understanding of the financial markets and the benefits of contracts for difference, as well as the risks involved. All of the following strategies require the use of leverage on our platform, which means that you only have to deposit a percentage of your full trade value to gain exposure to the markets. This comes with a high level of risk, which we will explore further on.

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Intraday trading is a popular short-term strategy that involves entering and exiting a trade with the aim of closing out the position by the end of the day. This is with the intention to profit from small but frequent price movements. As you are required to monitor price charts meticulously for this strategy, day traders often focus on price action and technical analysis rather than fundamental factors that may be affecting a financial instrument.

Example:

Let’s assume that a trader wants to speculate on a major currency pair such as EUR/USD, as this is known for having high liquidity and a narrow spread, qualities that are valued among short-term traders.

A day trader may study the support and resistance levels from the previous trading day in order to decipher possible reactions that the price may take when it arrives at those identified levels. They then open a CFD position at the buy price of 1.1710 at the market open. A successful day trade would involve the trader opening and closing multiple similar positions like this one throughout the day, and if the price were to rise slightly to 1.1750, he could then close out all positions before the market shuts. This would result in multiple profits from each position.

However, if the price continually slips to below 1.1700, for example, and is not rising back above the initial buy price, the day trader may decide to close out the position for a small but fairly manageable loss. This is an example of an unsuccessful CFD trade.

Trading the news is another short-term strategy that involves staying up to date with economic announcements and market expectations for the near future. News traders need strong decision-making skills and to be able to make quick judgements for potential trading opportunities. This is a particularly useful strategy for volatile markets that react quickly to external factors, such as oil, indices, certain stocks and currencies.

Example:

Let’s take an example of the 2016 referendum for the UK to leave the European Union (Brexit).

Given the controversial nature of the vote, a trader is looking to take advantage of fluctuating GBP prices. Before the first exit poll is released, our CMC GBP Index is trading at a buy/sell price of 1,007/1,006. The exit poll emerges, and it shows that a higher percentage of citizens are voting to leave, causing the trader to assume that the pound sterling will fall in value rather than rise.

The trader decides to take a short CFD position and sell the instrument at the sell price of 1,006. His prediction is correct and due to the shock of the unexpected news, GBP’s value suddenly drops against other currencies. The more points the instrument continues to move lower, the more profit he will make on the short side.

However, remember that prices don’t always continue the follow the path they originally take after a news release. For example, the pound sterling plummeted in value following the Brexit outcome but rallied a few months afterwards, showing that market reactions can reverse and head in an entirely different direction. Therefore, a news trading strategy is often relied on in the short-term only.

Financial hedging is a strategy that helps traders to offset risk within 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 on safe haven assets as a hedge, such as gold, certain currencies, government bonds, and defensive stocks, as these financial instruments could be considered less vulnerable to negative market shocks than others.

Example:

Let’s take an example of a pairs trade using CFDs.

Assume that an investor owns 1,000 Tesla shares on a separate stockbroking account and is concerned that the company’s share price will drop after a recent poor earnings report. He decides to short sell an equal of 1,000 Tesla shares using a CFD trading account in the hope that any losses on the shareholding position may be offset by a successful short trade.

Assume that Tesla’s share price does indeed fall by 10%. Although the trader’s shareholding account is now worth less in value, the trader has made a 10% gain on his CFD trade, and is able to buy the stock back at a lower price if he wants to. This is an example of a successful hedging strategy.

Position trading is similar to taking an investment-like buy and hold approach. Position traders can hold trades for months or even years, ignoring minor price action and focusing on long-term trends and overall movement. These types of traders tend to rely on fundamental analysis indicators, such as macroeconomic trends and historical price patterns.

Example:

Let’s say that a trader wants to hold PayPal stock for a long duration, as he sees the value in this blue-chip stock and thinks that it will increase steadily over time.

He buys a number of CFD units for PayPal at a price of $275. Position traders do not need to apply technical analysis or monitor price charts often; instead, he may choose to perform company analysis intermittently to make sure that the stock is still on track to increase. He could do this by calculating P/E ratios, forward earnings and analysing dividends that the company provides in its financial reports. Fast forward nine months and PayPal is now trading for $330. If the trader is happy with this figure, he can now close out his position with a $55 profit.

Remember that when carrying CFD positions overnight, as position traders do, you will incur holding costs. You will also be subject to commission fees if holding shares for a long period of time. We explain more about these further on in the article.

An effective CFD trading strategy can be difficult to master, so here are some tips that may come in handy for your next trade:

There are risks to consider when opening a CFD trade, as mentioned briefly throughout this article.

In particular, derivative trading requires the use of margin/leverage, which allows you to open a much larger position using borrowed funds in order to gain wider exposure to the financial markets. You are only required to deposit a fraction of the full trade value. While this is a benefit of CFD trading, it can also be seen as a risk, as it enhances the possibility of capital loss. Read more about margin in trading​ to learn how to utilise it effectively and safely.

Many traders choose to use risk-management controls when placing a buy or sell CFD position, which you can apply directly in the order ticket. These can include traditional, trailing or guaranteed stop-loss orders, depending on the level of risk you want to take. You could also look out for position sizing, rather than trying to take on a CFD position with an impractical number of units, consider what percentage of your total account value you are putting at risk with each trade.

Read more in our guide to trading risk-management​.