What exactly are Contracts for Difference (CFDs), and how can one create a system to profit from them? This article will address three powerful things to consider while creating a good CFD trading system.
According to Investopedia, the world’s leading source of financial content on the web, a CFD is “a tradable contract between a client and a broker, who are exchanging the difference in the current value of a share, currency, commodity or index and its value at the contract’s end.”
Did you know that pretty much any tradable financial instrument in the market is available in CFD Format?
CFDs are relatively new financial products. However, they have gained popularity among investors in the past decade because investors can actually have all the perks and shortcomings of owning a security without actually owning it.
The Power of Leverage on CFDs
Don’t get too much adrenaline rush, and start daydreaming about how you’ll use leverage to make a million dollars in a week. Don’t get it all twisted! It’s possible to do this with leverage, but it takes years of consistency and patience in your craft. It’s a double-edged sword.
CFD is a leveraged product that lets you use margin trading to increase your market exposure on any particular trade taken. Margin trading means a fraction of your open position will be put aside as collateral any time you open a position.
Leverage potentially gives you the power to invest more than your actual capital, thereby increasing your potential win by the leverage used. It also amplifies the market in any direction, making it a “double-edged sword” master and servant. Used correctly and respectfully, without greed and an effective system, one can make money most people dream of in life.
| CFD Using Leverage | Non-Leveraged Share trade | ||
| No. Of CFDs | 100 | No. Of Shares Bought | 100 |
| Total Value of Trade | $2500 | Total Value of Trade | $2500 |
| Deposit Required to Open Trade (Margin) | 30% | Deposit Required to Open Trade | 100% |
| Total Margin | $2500 X 30% = $750 | Deposit Required | $3500 X 100% = $2500 |
Source: Forex
Trading System
A trading system is a set of instructions for buying and selling securities to make a profit. It must be objective, verifiable, consistent, and quantifiable. The system is based on fundamental or technical analysis to prevent systemic risks from having catastrophic consequences for financial instruments. When developing a trading system, you should set clear objectives for yourself.
Trading System Explained
A trading system should outline your financial goals, including short-term and long-term financial needs, time horizon, tax implication, and risk tolerance level. Then, before you execute a trade, you have to watch the news and conduct technical analysis according to your plan.
What next once you execute your trading system? You should monitor the market and manage the open positions to make sure they align with your trading system. The trading system should help you keep track of the trade’s returns, risks, and impact on your portfolio.
Let us talk about the three powerful things to consider for an effective CFD trading system:
The 3 Key Components of a Good CFD Trading System
You should make sure these three key components are included in your trading CFD system despite the kind of system you decide to trade.
Trading Product
Financial instruments vary in trading complexity, risk, and liquidity. Therefore, it is essential to develop a well-balanced trading system that will require you to determine the potential added value to your portfolio.
Trading everything anytime will not let you gain quick mastery of your craft. Instead, it will often expose your emotions to the market and soon get you out of business.
For example, trading CFDs are complex and high risk. On the other hand, it requires a comparatively lower upfront investment due to the leverage available and offers more flexibility than stock trading. Therefore, selecting possible combinations of financial instruments is a prerequisite for an optimal portfolio. In addition, frequently adjusting your positions is vital, considering the volatile nature of the market.
Your Risk Tolerance
Risk tolerance is the degree of risk a trader is willing to withstand in their trading journey. One factor determines the CFD trading system that you will adopt. However, it is bound to change throughout your trading journey. Therefore, you should assess it more often, especially during financial or lifestyle changes.
Short-term traders or investors should consider time-based risk tolerance to craft an optimal CFD trading system. On the other hand, you can identify trading opportunities when the market is volatile, thus tolerating higher risk levels as a long-term CFD trader.
The Stop-loss feature should be well defined in your CFD trading system. This gives you an edge over the market in the long run since you will be ready to lose only a given percentage per trade while the trade goes against your systemic prediction.
Stop-loss is a highly recommended feature. No expert CFD trader goes on a trade without an exit plan. Thus, you should be in a position to know your entry level and your exit level before actually taking any CFD positions.
Trailing Your Stop-loss to Manage the Risk
Trailing stop-loss! Sounds good, right? Not until you have been stopped on three or four beautiful trades then you be all over the place emotionally. Then, boom, your account is blown! Then you start blaming trailing stop-loss as your emotional trigger.
Trailing stop-loss helps you as a trader to secure some of the profits the market offers and keep your positions running for a long time to hit your target. Sound like something magical, right? Only when used wisely. Make sure you use the feature wisely to maximize your profits and minimize losses, not the other way round.
Leverage Technical Analysis
The charts tell a story the news and market makers feed it. You must leverage technical analysis to get the true story and benefit from it.
Technical analysis gives you power as a trader to identify opportunities and potential risks before getting into a trade. There are various ways to conduct technical analysis. The most popular one is price action through the help of tools such as a stochastic oscillator, Relative Strength Index, and on-balance volume, among others.
The technical indicators can help you as a trader gauge the market movement and generate buying and selling signals for the best strike price.
Closing Thoughts
Make sure that whatever CFD trading system you choose has these three features so that you can profit from your trading activities. After all, they’re the only things that can tell you whether or not your investment will be profitable.
