Articles of Interest

Before you start trading Contracts for difference it is important to obtain a few tips from the professionals to make sure that you do not make many of the costly mistakes that newbie traders make. Below are three trading pointers which will help you in your CFD trading success.

1. Manage your Positions
Repeatedly new traders spend a significant amount of time selecting, planning and executing new positions, however they regularly make the mistake of exiting these trades with much less thought. This is unfortunate as it is the exit which will determine whether a trade has been profitable or not.

It is human nature to take profits hastily while the concern of incurring a loss will see the same trader leaving poorly performing positions open in the hope that prices will move in the correct direction and reduce losses or even turn them into profitable trades.

Numerous new traders forget about the old saying “Let your profits run and cut your losses short”. As the proverb states if you have a profitable position, it is best to allow that trade to realize its full potential, as opposed to closing it out at the very first sign of a small return. On the other hand, if you happen to hold a position that is moving against you, it is best to move quickly to exit that position, before the loss becomes too great.

If you're managing your trades properly, your average winning trade should be significantly larger than your average losing trade. Once you have the discipline to buy and sell in this way, you should be able to achieve overall profitability even when only half of your trades are winners. A lot of traders make the mistake of not closing poorly performing positions fast enough. One tool that makes this less complicated is a stop-loss order.

After you have determined a price level that corresponds with the amount of risk that you are prepared to take on a particular trade, a stop-loss order can be placed at this level to automatically close out the trade. This removes the human aspect from the exit, reducing the risk that the emotion of hope will interfere with rational decision making.

It is important to understand that a stop-loss order simply provides a trigger point for the execution of an order. If a sell stop has been placed on a long position, the stop-loss will be activated if the price trades at or beneath the nominated stop level. Occasionally, this may lead to trades being executed a price that is less favorable than the nominated stop-loss price. This is known as slippage.

2. Understand the instrument that you're trading
Being over-the-counter products, there are various differences in the contract specifications of CFDs. If you are thinking of trading these products, it is critical to know what these specifications are.

You must also be aware of the influence that foreign exchange fluctuations might have on your holdings. If the base currency of the CFD rises against the base currency of your account your profits could be eroded by any currency fluctuation or your losses might be made worse.

Most CFD traders trade CFDs based on stocks listed in their home country. The simple reason for this is that traders are more comfortable trading CFDs that they're familiar with. Most traders also benefit from the convenience of trading their home market as it isn't practical to sit up for half the night to trade a Contract for difference over a share listed on an exchange in another part of the world?

In lots of cases it is much better to stick with CFDs based on equities listed on exchanges that you're familiar with as opposed to trading Contracts for difference based on stocks listed on markets you don't fully understand.

3. Use the correct order types
You should treat trading as a serious business. As such, you must take some time to make sure that you thoroughly understand the tools of your business. Many CFD traders miss chances or have been stopped up out of trades at the wrong time just because they placed the wrong kind of order.
                   
At the very least, be certain to become familiar with the following order types:

Market order: This kind of order is utilized to execute a trade at the present market price.

Stop-order: This order type is utilized to exit a trade at a specific price. Stop-orders are placed at a level that's worse than prices presently available in the market. On a long position, the stop-loss order to sell would be located below the present market price. Conversely, on a short position, the stop-loss order to buy would be placed at a level greater than present market prices.

Limit order: A limit order is used to exit a trade. Limit orders are placed at a level that is better than the present market price. When seeking to lock-in profits on an open long position, a limit order to sell would be placed at a level greater than current market prices. If seeking to lock-in profits on a short position, a limit order to buy would be placed at a level underneath current market prices.

You must always understand that as Contracts for difference are leveraged and that buying and selling them can be risky. However if used correctly Contracts for difference will become a valuable tool within your trading arsenal.

To find out more about CFDs you can download our complimentary CFD Guide.

Like all financial products there are risks trading CFDs. Risk is generally linked to returns, the riskier the investment the higher the potential returns, however if risk is managed correctly it can be significantly reduced. When trading CFDs this can be done through the use of stop-loss orders and simple portfolio hedging. This article explains the key risks associated with trading CFDs and what can be done to reduce them without having an effect on the significant returns that CFDs can provide.

Before trading CFDs you must understand that CFDs are a leveraged product and that leverage can work for you as well as against you. Like all leveraged products a small price movement can result in significant returns but also significant losses. The variety of orders types available for CFD traders allow the risks associated with adverse price movements to be significantly reduced. CFD traders are able to set their orders at prices which they are prepared to close out their positions and realise a loss. Common order types used to mitigate risk are stop-loss orders, trailing stop-loss orders and guaranteed stop-loss orders.

Stop-loss orders
This is the most common order type used by traders to manage risk. A stop-loss order is simply an order to close an open position that is placed at a price below or above the current market price at a price that the CFD trader is willing to close out their open position. It is important to note that stop-loss orders can be prone to slippage should the price of the CFD gap, this is a common occurrence when trading share CFDs.

Trailing Stop-loss orders
Trailing stop-loss orders are similar to stop-loss orders with the exception that the price of the order moves in accordance with a pre-determined distance from the current trading price, this distance is set by the trader at the time of placing the order. It is important to note that the price of the order will only change if the price of the instrument moves in a favourable direction, should the price move against the trader the price of the trailing stop-loss order will not change. This order type works like a ratchet, in that it can be used to lock in profits as the position moves in favour of the CFD trader without the need for the trader to constantly change the price of their stop-loss order.

Guaranteed Stop-Loss orders
Guaranteed stop-loss orders have become common in recent times due to traders being able to guarantee their potential losses. This order type is commonly used when trading share CFDs simply because share CFDs are prone to slippage and gapping during the opening phase of the market. It is important to note that when using guaranteed stop-loss orders your CFD provider will often charge you a premium, this is like an insurance premium guaranteeing that you will be filled at the price your stop-loss order is placed.

Aside from using orders to manage your risk when trading CFDs many traders use other financial products such as shares and options to hedge their CFD positions.

Shares are commonly used to hedge CFD positions or vice versa, these are often used by traders that hold a portfolio of stocks as well as a short term CFD trading account.  CFDs are often used to trade short term price movements of the stocks within their portfolio without having to sell their stocks and realise any capital gain.

Options are used by some CFD traders as a form of guaranteed stop loss. Options have an advantage over guaranteed stop-loss orders in that they are often cheaper. Hedging CFD positions using options is commonly used by more sophisticated traders that understand the core components of an options contract and how to choose the most appropriate contract to hedge their CFD position.

Aside for managing risk using order types and hedging strategies all CFD traders should ensure that they adopt strict money management techniques, meaning that they should not utilise excessive leverage or overexpose themselves to one particular CFD or sector. Utilising too much leverage is the single most common mistake made by novice CFD traders.

Before opening a real CFD account you should ensure that you practice trading on a demo account to so that you understand how to use the multiple order types available that will help you manage your risk. Remember CFD trading can be extremely rewarding if the risks are controlled.

To learn more about CFD trading you can download our free CFD Guide.