Overview
CFD trading is a type of trading instrument which has become an increasingly popular means for investors to enter the financial markets. CFD is an acronym that stands for Contract or Difference, and these are offered by almost all online brokers today.
CFDs are provided along with a variety of assets such as forex, commodities, and spot metals, although they differ from these in that CFDs are essentially a form of derivative trading.
As an instrument of derivative trading, CFDs gain their value from the movement of an underlying asset, rather than from the value of the asset itself.
As such, CFD trading involves speculating on price movements without owning the underlying asset, which allows traders to avoid some of the risks and disadvantages of traditional trading.
As with any type of trading, speculative or otherwise, a trading strategy is vital for any trader’s success, as randomly making trades is a sure recipe for failure.
A coherent trading strategy will allow you to treat your trading as a business, without letting emotion or psychological impediments affect your decision-making so that you can work towards making profits on a consistent basis.
In any event, it is always important for a trader to stick to their CFD trading strategy, as the parameters of this strategy will mitigate any impulsive trading.
That said, it is also important for a trader to be able to determine when a strategy is no longer working for them, which is best done by keeping a record of wins and losses, as well as by back-testing your strategy.
Trend Trading
When the price of an asset is moving in one overall direction, such as up or down, that is called a trend.
Trend trading is a trading strategy designed to take advantage of uptrends, which happens when the price tends to make new highs.
Trend trading also tries to take advantage of downtrends, which is when the price tends to make new lows.
In addition to looking at swing highs and lows, trend traders make use of other tools like trendlines, moving averages, and technical indicators to help identify the trend direction and potentially provide trade signals.
Swing Trading
Swing trading is a short-term trading strategy that focuses on to make making a profit out of price changes in either direction, often in stock.
Typically, the trader will only hold the position for a number of days before selling, while paying attention to the movement in value of a number of different stocks before entering at the appropriate level, before leaving the position shortly after with a profit.
The position is commonly held from one to four days, although some traders do choose to hold their position for weeks.
Scalping
Scalpers focus on making as many small profits as possible, which is entirely different from other strategies that attempt to optimize positive trading results by increasing the size of winning trades.
To this end, scalping works by increasing the number of wins, rather than focusing on the size of these wins.
As such, the scalping strategy focuses on profiting off of small price changes, which usually happen after a trade is executed and becomes profitable.
Scalping requires a trader to have a pre-determined exit strategy because one large loss could eliminate the many small gains the trader worked to gain.
Therefore, it is critical for scalpers to have the right tools at their disposal, including a live feed, a direct-access broker, and the perseverance to be able to continuously place multiple trades.
Mean reversion
The mean reversion strategy makes use of technical analysis, which includes moving averages, to capture assets whose recent performance has differed considerably from their historical average.
Mean reversion traders work to take advantage of the eventual return of that asset to its normal trajectory.
Mean reversion operates on the basis of the theory that prices, and other measures of value such as price-to-earnings (P/E) ratios, always eventually move back towards the historical mean.
Range trading
The range trading strategy focuses on identifying overbought and oversold assets (also known as areas of support and resistance). Range traders buy during oversold/support periods and sell during overbought resistance periods.
Range trading can arguably be implemented at any time, but it is most effective when the markets lack direction with no discernible long-term trend in sight.
It is also good to remember that range trading is at its weakest during a trending market, especially if market directional bias has not been accounted for.
Breakout strategy
The breakout strategy is relatively common and quite popular amongst CFD traders, and it primarily involves spotting the key price level for a given stock.
When the price reaches the trader’s key level, they buy or sell (whichever is appropriate to the current, prevailing trend).
As such, the secret to a successful breakout trading strategy is to make sure that you avoid making these trades at a time when the market is not sending clear signals about which direction the overall trend is moving.
Those using the breakout strategy need to have a definite and clear comprehension of the trend and its direction in order for this strategy to be successful.
Contrarian investment strategy
This is fundamentally a market timing strategy, which operates on the understanding that all trends are only temporary.
To apply this strategy, the trader looks for a stock that has seen its price experience a downward trend. The trader then selects points that they believe to be at or near the end of that trend, and buys in anticipation of a move in the opposite direction.
Of course, the CFD trader can employ the same principle in reverse by short selling a stock that has been increasing in price, in anticipation of a sudden change in price direction.
Traders using this strategy make use of Wave Theory and similar analytic tools in order to help them identify when these shifts are most likely to occur.
Rebate Trading
As the name suggests, Rebate traders search for the rebates which are offered by some trading networks on certain types of trades.
To this end, a rebate trader is less concerned with the actual amplitude of a price move than they are with making a profit on the offered rebates, and these will be where the majority of this strategy’s profits come from.
News playing strategy
The news playing strategy can be seen as one which makes use of opportunistic trades by anticipating the movement of a stock as a result of developments in the news. This strategy therefore measures market sentiment and trades on that basis.
As such, news traders seek to sell before the price plummets, and when they have to buy those shares back to close out their position, the price has fallen markedly, allowing them to profit on the difference.
This is a fairly simple strategy to execute, and primarily involves staying abreast of any and all news developments in the markets, and understanding the implications on price of the headlines these headlines in order to profit from current events.
Double red strategy
Traders who use the double red strategy take advantage of a system that looks for short-term reversals in price.
They will be able to identify these reversals because they signaled price action and resistance.
By analyzing candlestick charts, when two bearish candles appear after a resistance level test, then this strategy can be applied. The signals generated with this system are good for 30-60 minutes and no longer.
This strategy is best adopted when there is no major news event taking place.
Pinocchio strategy
This strategy is named after Pinocchio to reflect the idea that whenever Pinocchio told a lie his nose grew, and so this strategy requires traders analyze the market in order to look for false trends.
As such, traders try to identify an asset that has been moving in one direction for a while but is in fact about to move in the opposite direction even though this is against the trend of the market.
An asset that is likely to be a Pinocchio is one that has opened at a low price and closed at a much higher price. The same can be true in reverse: the asset has opened at a high price and closed much, much lower.
The strategy can be used by beginner traders to help gain a deeper understanding of the market, and can also be used to supplement other strategies as well as by itself.
Portfolio or basket trading strategy
Portfolio trading, which can also be called basket trading, is based on the combination of different assets belonging to different financial markets (Forex, stock, futures, etc.).
The concept behind portfolio trading is diversification, one of the most popular means of risk reduction. By smart asset allocation, traders protect themselves from market volatility, reduce the risk extent and keep the profit balance.
By mixing up different assets in your portfolio which are in negative correlation, with one security’s price going up and the other’s going down you can keep the portfolio’s balance, hence preserving your profit and reducing the risk.
Hedging Strategy
A hedging strategy is a set of measures designed to minimize the risk of adverse movements in the value of assets or liabilities. Hedging strategies usually involve taking an offsetting position for the related asset or liability.
Hedging strategies give traders the chance to limit their losses without using a stop-loss strategy.
Stop-losses are a critical tool used in Forex trading to limit losses if the trade does not go as planned.
To this end, hedging strategies work the same way as a stop loss order in terms of limiting losses. However, the advantage of hedging is that traders can also make money on the hedge trade if they carefully select the second trade.
Carry Trade Strategy
Carry trade is the borrowing or selling of a financial instrument with a low-interest rate, then using it to buy another instrument with a higher interest rate.
The trades will either be going short on the lower interest rate currency or going long on the higher interest rate currency.
To this end, the carry trades need to be held for a prolonged period of time using leverage for enhanced returns and traders try to take advantage of interest rates spread between the two assets.
Momentum trade strategy
Momentum trading is a technique in which traders buy and sell according to the strength of recent price trends. Price momentum is similar to momentum in physics, where mass multiplied by velocity determines the likelihood that an object will continue on its path.
In financial markets, however, momentum is determined by other factors like trading volume and rate of price changes.
Momentum traders bet that an asset price that is moving strongly in a given direction will continue to move in that direction until the trend loses strength.
Daily pivot trading
Pivot points are technical analysis indicators. A pivot point uses a previous period’s high, low, and close price for a specific period to define future support.
Then, they apply calculations to determine the points. Additionally, they determine stock market trends over different time periods.
The main pivot point is the most important price level for the day. The pivot point is the balance between bullish and bearish forces.
When prices are above the pivot point, the stock market is considered bullish. If prices fell below the pivot point, the market is considered bearish.
Weekly trading
Generally, a weekly strategy in the forex market is based on a number of tools for avoiding excessive risks.
Namely, it assumes a lower position size, and the main focus in the investigation of trends is put on the moving averages and extreme points of the weekly charts.
Also, it should be understood that weekly traders bear opportunity costs, as they deposit funds that could otherwise be used for more profitable shorter-term transactions.
Price action strategy
Price action trading is the discipline of making all of your decisions in trading from a clear price chart.
This implies that there are no lagging price indicators present, except for, perhaps, some moving averages that may help to determine dynamic resistance and support areas, along with trend direction as well.
Technical analysis strategy
Technical analysis is a form of analysis used by traders to evaluate future price action based on historical price data.
Many traders use technical indicators and charting analysis as an approach to analyzing the markets and spot potential trading opportunities and suitable entry and exit points.
Support and resistance trading
Support and resistance are powerful pillars in trading and most strategies have some type of support/resistance analysis built into them.
Support and resistance strategies can either be based on price respecting these levels (range bound strategy) or anticipating the break of support and resistance (Breakout and pullback strategies).
Volume Trading
Volume trading requires you to pay careful attention to the forces of supply in demand.
Volume traders will look for instances of increased buying or selling orders. They also pay attention to current price trends and potential price movements. Generally, increased trading volume will lean heavily towards buy orders.
Multiple time frame analysis
Multiple time-frame analysis involves monitoring the same currency pair across different frequencies (or time compressions).
Typically, using three different periods gives a broad enough reading on the market, while using fewer than this can result in a considerable loss of data, and using more typically provides redundant analysis.
Fundamental analysis
Fundamental analysis (FA) is a method of measuring an asset’s intrinsic value by examining related economic and financial factors.
Fundamental analysts study anything that can affect the security’s value, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors like the effectiveness of the company’s management.
Trading on the basis of market sentiment
Technical indicators can help investors measure market sentiment. Market sentiment refers to the overall consensus about a stock or the stock market as a whole. Market sentiment is bullish when prices are rising, and bearish when prices are falling.
Fading Trading
Fading trading strategy means that you buy when the market is selling and sell when the market is buying. While the opportunity for large short-term gains is possible with a fade strategy, a successful fade trader will not engage in this strategy blindly.
Spread or pair trading
A pairs trade is a trading strategy that involves matching a long position with a short position in two stocks with a high correlation.
A pairs trade strategy is based on the historical correlation of two securities; the securities in a pairs trade must have a high positive correlation, which is the primary driver behind the strategy’s profits.
Stochastic oscillator strategy
The term stochastic relates to the point of the current price in relation to its range over a recent period of time. By comparing the price of a security to its recent range, a stochastic attempts to provide potential turning points.
Conclusion
CFDs, or contracts for difference, are derivative off-exchange instruments that allow traders to speculate on longer-term price movements.
Traded directly with the broker rather than the market, CFDs are contracts to buy or sell an underlying instrument at some future point, at a price stipulated today.
Like spread betting, CFDs allow traders to adopt highly leveraged positions and can provide traders with an alternative instrument on which to base their market and index projects. There are numerous trading strategies applicable to trading CFDs.
The importance of CFD trading strategies is hard to overstate, and without a coherent and defined plan of action, it is extremely difficult to get to a stage where your CFDs consistently deliver a profit.
Trading anything without a strategy is like playing golf blindfolded – while you might hit the ball once or twice, it’s far more feasible to open your eyes and take account of the wider picture with a strategic approach to your CFD trading.
Choosing which CFD trading strategies to employ for the best effect is something of a balancing act.
It requires you to factor in a number of considerations when making that decision, including your appetite for risk, your trading objectives, the impact of leverage on your positions, and your available capital.
Nevertheless, finding a trading strategy that works for you is the first step towards more consistent CFD trading, and could set you on your way to building a long-term, profitable trading career.
CFD trading strategies come in a variety of different guises. Some are based on going long, while others are based on selling weak markets shortly.
Others focus on the turning point of markets, while others trade within the boundaries of previous price performance.
But aside from the specifics of the nature of an individual strategy will be an underlying concept – it will either focus on a long-term investment strategy or a shorter-term investment strategy.
While both are equally popular in trading as a whole, CFDs tend to fall more often (although not exclusively) into the short-term camp, for the fundamental reason that financing costs can make long-term leverage a problem.
Frequently Asked Questions
CFD trading is a type of trading instrument which has become an increasingly popular means for investors to enter the financial markets. CFD is an acronym that stands for Contract or Difference, and these are offered by almost all online brokers today.
CFDs are provided along with a variety of assets such as forex, commodities, and spot metals, although they differ from these in that CFDs are essentially a form of derivative trading.
Can you make a profit from CFD trading?
Yes. Over the years, CFD trading has gained popularity as a less capital-intensive way to trade and some of the benefits of trading CFDs include the ability to potentially make money in both rising and falling markets.
Which are the best CFD trading strategies?
Check our comprehensive list of the 27 best CFD trading strategies directly from the SA Shares website
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