Before you risk any of your hard-earned money, you must always have a well thought out strategy before going into CFD. By being able to trade based on the margin’s movements without purchasing the underlying asset, it is easily distracting and tempting to trade in the different available markets for CFD without actually knowing what you are getting yourself into.
While leverages come into play and may significantly increase your trading returns, it is a double edge sword and can also lead to big losses. Find out some of the benefits of going into Contract For Difference.
What is Contract for difference?
A Contract for difference or CFD, is a form of trading that is based on movements in different underlying assets such as currency pair, cryptocurrency, stock, index or commodity. Unlike other forms of trading, there is no need to actually own shares but instead, CFD focuses on the change in price from which you can project.
The basis is from the onset of purchasing or entering the trade up until you exit it. When you purchase a CFD, you may be granted a dividend from the company on the underlying shares.
Comparable to stocks
Some traders find CFDs very efficient and quite desirable for investors who are looking to trade stocks. A factor to consider in CFD is the leverage that is used in CFD trading, which is much higher than the leverage you may receive with your stockbroker. Many CFD brokers offer leverage of 20-1 which would allow you to purchase 1 CFD of Amazon for as little as $90 per CFD vs. the initial $1800 price per share. For the same $1,800 that you would use to purchase 1-share of Amazon stock, you could buy 20 Amazon CFDs.
Trading with Leverages
CFD has embedded leverages but may differ from one broker to another or asset to another asset. This feature in CFD trading enhances your returns, and allows you to increase the capital you control with borrowed capital. It is very important to comprehend how leverage can impact your returns.
If you are able to buy $5,000 of EUR/USD using 400-1 leverage, you may purchase 0.25% ($5,000 * 0.0025 = $12.5) and move to either doubling your investment or absorb heavy losses. Some traders might feel that leverages are quite the advantage and is highly attractive, but uncalculated risks may very well cause more bit of a problem instead of help
Prioritizing Risk Management
Just like any form of trading, CFDs can be very risky. Planning is very important when entering a trade and to avoid unnecessarily huge risks, you are advised to come up with a risk management plan that enables you to limit the amount of capital you place in each trade. If you plan to trade $5000 of your portfolio, you are advised to start limiting your trade at $500 for each trade.
This method will enable you to enter trades with managing the possibility of loss that will not totally ruin your portfolio. Nobody comes into CFD without some forms of loss at the start. Allow yourself to have room for losses that are based on your learning curve up until you get the hang of the trading.
Another strategy you may incorporate is by cutting your losses and letting your profits run. Never continue with a losing streak and it’s more important that you live to trade another day. Going hard or going home does not apply in CFD and most likely, with that kind of mentality, will lead you to incurring heavy losses and halting any chance of potential profits in the future.