Derivatives allow traders to hedge against market risks. Contracts for Difference (CFDs) are one such derivative instrument that allows traders the flexibility to trade both rising and falling markets. Margin trading further allows them to efficiently use their capital, across a range of financial markets, all from a single trading platform. Beginners too can opt for CFDs, on account of the flexible contract sizes that lets them start with smaller lot sizes.
However, leveraged CFDs entail huge risks as well. During times of high market volatility, high leverage can magnify losses, when the markets take an unfavourable turn. Therefore, it is vital to have proper risk management tools in place and trade with an objective mindset.
Despite the best precautions, traders do make mistakes in CFD trading. Here are some of the most common ones, so that you can be cautious before entering into the next trade.
CFD traders often take the flexibility for granted. Just because one has the freedom to short positions, doesn’t mean that there are no risks involved. Also, trading decisions taken in the spur of the moment can significantly hamper long-term goals. It is necessary to have a tried and tested trading plan in place and stick to it.
Without a plan, traders might let behavioural biases take control of their decisions. Plans need to be made according to the decided capital, risk-reward ratio, leverage ratio, profit goals, trading style and trading system. A sound plan allows traders to stay on the right track. Trades that don’t fulfil the criteria for these plans can be avoided.
Although more convenient than many other trading instruments, CFD trading is definitely not easy. Traders need to study the markets carefully before adopting strategies and making decisions to buy or sell. Is the market overbought or oversold? Will volatility increase or decrease in the near future? What reports could spur sudden volatility and how will they affect the value of the underlying asset?
Apart from fundamental analysis, many technical indicators can be used to judge where the market is headed. Trend following tools and volume indicators can prove important in identifying suitable entry and exit points. Applying risk management measures, such as stop-loss and take-profit at the right places is vital as well.
In short, traders need to take CFD trading seriously and invest time in building knowledge.
Traders often allow losing trades to run on for a long time, in the hopes that the market will eventually turn in their favour. While the markets do turn favourable eventually, this might happen only after the trader’s entire trading account has been wiped out by losses. When trading CFDs on leverage, losses are multiplied. This is common in day trading or short-term trading strategies, where techniques are dependent on frequent price movements to realise gains.
Investment psychology is an essential part of successful CFD trading. Emotions like fear, greed and over-confidence can lead to bad decision making. This is why having a defined plan helps in the long run. Defined stop-losses and additional trailing stops can help traders avoid the urge to over-trade. Losses are inevitable, but at the end of the day, one needs to work out how to not let them eat into profits.
The choice of trading platform, MT4, MT5 or any other platform, will have a significant influence on trading outcomes. If traders are unaware of how to operate the features of their chosen platform, they might miss out on good trading opportunities, or, worse, incur losses. One has to be comfortable with the controls and indicators, and when and where to find them. It is a good idea to learn about the various order types and use them at the right places. Navigation is much easier on a platform with a user-friendly interface.
Execution speed also needs to be checked. Latency can lead to increased slippage. To fully understand the functionalities of the platform, one can use a demo account. This will help you understand the markets and the platform without having to invest any real capital.
CFD trading allows traders to assume multiple positions in a range of financial instruments. While a diversified portfolio is a good way to hedge risks, entering markets you are unfamiliar with can have adverse consequences. For starters, the market needs to suit the trading strategy. For instance, major currencies with tighter spreads are more suitable for intra-day trading strategies, rather than exotic or cross pairs.
The fundamental aspects need to be looked into as well. Country-wise risks, geo-political uncertainties, company earnings profiles, central bank policies, and other breaking news can lead to price volatility. Markets often show a correlation with each other. For instance, oil markets soar with a declining US Dollar and gold is negatively correlated with risk assets. Having open positions, all in the same direction in the same market, could double your risk. At the same time, opening positions in a lot of markets can take a lot of work. One must be prepared to invest time monitoring these positions too.
Mistakes are a part of the learning process, and they are bound to happen, despite our best efforts. The key is to use them as opportunities to learn and improve your trading style and objectives. Having a trade journal could be valuable to keep note of the twists and turns of the market. Also, regular practise on a demo account can sharpen skills, while also helping formulate new strategies.