Speculating with CFDs
Traders often follow their gut instincts about trades. Though they may not be able to explain precisely why a share or index is going to move in one direction or another, they just know what is going to happen. Anxious not to miss the profits that would emanate from the movements they've prophesied, they then place speculative trades.
Typically short-term, speculative trades are generally coupled to major market events such as central bank interest-rate decisions and company results. Traders want to capitalize quickly through a timely entry into trades that will see prices take off on the news, and then a timely exit with their profits intact.
CFDs are the speculator's investment tool of choice largely because they have the advantage of leverage that allows traders to maximise exposure whilst minimizing investment. Yet, because in speculative trades leverage can enhance not only gains but losses too, you should never place trades without utilizing trailing stops and other risk-management techniques.
In this section we will describe some typically speculative opportunities and explain how to grasp them:
Speculative trading opportunities tend to have one unifying feature: their link to news announcements. Such announcements may contain the government's latest employment figures or they may be a company's quarterly earnings. Either way, they frequently have the potential to cause dramatic shifts in the market.
Examples of news announcements that could precipitate speculative opportunities are:
- Breaking news
- Company reports
- Economic data
- Index additions/deletions
Breaking news announcements are unscheduled events that can wrong-foot traders and are therefore not so easy to capitalise on. Breaking news like a merger announcement should be beneficial to share and CFD prices, though occasionally the wisdom of a merger is not apparent and the price adjustment will reflect that. Yet other breaking news announcements like fraud charges against a company's CEO are usually harmful to share and CFD prices.
As you might expect, negative news depresses CFD prices lower whilst positive news lifts them.
Company reports provide information regarding recent company performance and plans for the future. Scheduled well in advance, they give traders every chance to prepare themselves and take full commercial advantage of their contents.
Company reports are not only publications of results for the last quarter, half or year. They should also anticipate trading during the next six months and this will impact on prices shares and CFDs. Traders need to digest this information and form opinions on it.
When a company's report shows it performs well and will continue to do so, its prices tend to move higher. Of course, the converse is equally true. Poor and pessimistic reports depress share prices.
Economic data emerges in news releases commonly scheduled months in advance, offering traders the opportunity to consider the evidence, second-guess the announcement and capitalise on the market movements that they feel will inevitably follow.
Economic data includes inflation, gross domestic product (GDP) information, interest rate announcements and unemployment figures, all of which tend to influence broad markets rather than individual companies. It therefore makes sense to utilise index-based CFDs when speculating on these announcements.
When economic data indicates that the economy is buoyant, share and CFD prices tend to move higher. If that data is poor, however, prices will usually fall.
Index additions/deletions occur when major market-tracking companies such as Standard & Poor's adjust the composition of their indices. This might happen, for example, if a company can no longer meet market-capitalization requirements and is therefore de-listed from the S&P 500 index .
Index additions and deletions usually occur at prearranged times though the identity of the individual shares involved is not divulged until the announcement is made. Traders may well realise which shares are likely to be affected, but they cannot confirm that before the announcement.
Being added to an index typically raises a share's demand and its price. It will of course then be required as a component of index-tracking funds. Conversely when shares are de-listed the index-tracking funds sell the share, and its price typically falls.
The Expected is Already Priced In
One important thing for speculative traders to remember about opportunities precipitated around news announcements is that expected movements are already priced into CFDs.
Investment analysts, economists and other market participants fervently analyze anticipated news announcements, trying to second-guess the consequences of the news on pricing. Whilst they are unlikely to entirely agree on anything, they do generate a consensus that is useful. This consensus, containing the average estimate, allows traders to capitalize on price movements once the news announcement is released. This is because the average estimate will already be "priced into" the value of the CFD. We will explain how this occurs.
After their analysis, traders take advantage of anticipated CFD movements. They don't wait for announcements. They need to pre-empt the market. So, by the time an announcement is released, most major players have already placed their trades.
When news announcements accord with average estimates, CFDs barely move. This is because most big traders have already placed their trades. Yet, when news announcements differ from the average estimate, CFD prices must adjust - either up or down - to accommodate the economic reality. This adjustment creates opportunities for the quick-witted to speculate.
Identifying news announcement or other stimuli that should cause prices to move will then provide opportunities to capitalise on price movements in three ways:
Entering trades immediately after an announcement is fraught with difficulties. This is because prices tend to adjust sharply when investors have incorrectly guessed the news. So to do this you must get the news quickly, evaluate it quickly and then enter your trade order quickly. Moreover, you need to do this before the price has already taken off. And it will do that quickly too.
Traders jumping into trades after the announcement usually must pay more for CFDs or sell them for less. Price movements that occur between the time when you enter trades and when those trades are filled are called "slippage." It can obviously be frustrating so, if you would be uncomfortable with slippage, then you should choose one of the other two methods for reacting to, or 'trading on,' the news.
Most CFD traders who trade on news choose to wait until new trends are established. This is typically the easiest way to capitalise on it, because initially the CFD price will fluctuate as investors speculate on how the underlying asset will trend. Once this fluctuation has abated, it is a good time to participate, but traders who work this way need to learn to ignore the superfluous 'noise' before a clear and enduring trend settles. Doing so gives them an advantage over other traders, those who enter too quickly and are caught out by early reversals and prices that trigger their stop-losses.
The direction in which a CFD is going to move is usually clear within 2 to 5 minutes of the news announcement that sparks its movement. Those few minutes will be ample time to shake out any investors trying to buck the trend so it makes sense to use short-term charts - ideally 1 or 2-minute charts - to monitor price movements after announcements.
Placing entry orders prior to announcements is the most profitable way to trade the news - assuming that you are correct and that the CFD moves in the preferred direction. By placing orders before the CFD moves in any direction at all you have the advantage of entering the trade at the price you want and don't have to worry about slippage. When the CFD reaches your pre-determined entry price you will be placed into your trade.
Yet this is risky because the market fluctuates wildly immediately in the aftermath of announcements and will take a little time to settle down. Ultimately the majority of participants perceive the news to be bullish or bearish then act accordingly. In the meantime, you could be knocked into the trade once your entry order is hit, then knocked right back out of it once the CFD turns around and hits your second entry order.
To prevent that you can delete your second entry order once the first entry order is hit, yet you should still place a stop-loss after you hit your first entry order.
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