CFDs are sophisticated products that deliver an array of opportunities for investors. The successful approach is to develop a plan based on your particular needs and risk attitude.
Strategy theory is something that will take a lifetime to learn. But you don’t have a lifetime’s opportunity to prepare the investment choices of today carefully. Most creditors use this tactic, seeing their CFD account solely as a hedging mechanism to reduce their equity portfolio’s future losses by taking advantage that CFDs will still make you money in a declining market. Yet, how else can one use a CFD account? What techniques would an investor be trying to employ?
Here, we refer to the CFD industry leaders and discuss what approaches to consider when investing in this tool.
Head of Trading at CMC, Geoff Langham, says you need to understand what kind of investor you are before building a strategy. He asks: ‘What are you expecting from your investment? ‘What amount of danger will you be experiencing? What is it you can afford to lose? Second, what do you know? Trading CFDs can whet the appetite of risk-takers.
‘CFD traders have a good risk tolerance, on the whole. We are also sophisticated investors combined with the abundance of both fundamental and technical analysis currently accessible by online brokers. They are highly confident in dealing in an environment that the companies have historically just experienced. The greatest single factor of trading strategies for any trader is his or her risk tolerance. ‘CFD traders have a good risk tolerance, on the whole.
They are now professional investors and combined with the abundance of both fundamental and technological analyzes now accessible by internet exchanges, they are highly comfortable trading in an environment that the companies have traditionally just enjoyed. ‘FinSpreads’ Angus Campbell agrees: That really depends on what type of investor you are.
If you’re a fairly risk-averse investor, you’d be looking to invest in substantial amounts on stock, like Vodafone. A stock that doesn’t really change that much, or ITV, some of the slightly lower-priced stocks inside the index. ‘If you’re a risk-loving investor, you might want to consider making slight changes to your strategy.
You’d use a more modest sum on a more volatile stock. Such as the Royal Bank of Scotland, AstraZeneca, and Standard Chartered, and maximizing your assets. It depends on whether you’re going long or short. If you’re going short, you might want to find a bigger capital block because you will earn more interest from that position. In short, you’re paid for having the larger amount. You’re looking to go long for a spot like £20,000′. CFDs are obviously perfect to use as part of your overall trading strategy, given that they take advantage of both rising and declining prices.
Using a CFD, investors can open up a long or short position on thousands of UK, US, and European inventories. This is difficult and expensive in the conventional stock market, making CFDs suitable for risky trading. Going long is the simplest and most straightforward strategy to take advantage of an upward trend in rates and has the bonus that no stamp duty is payable.
There is no limit to maintaining a long position. But there comes a time when staying a long time will turn into an uneconomic tactic for continuing to use. Much CFD trading focuses on short-term trading. So any distinction between that and long-term strategy is only made by comparing the savings achieved by not incurring stamp duty with the expense of a long CFD funding.
The additional cost of going long over a traditional purchase on a CFD place is only the interest cost.
The interest charged on a long CFD, for example, is about 6.5 percent of the contract value. The 10 percent difference invested is kept to guarantee the contract’s efficiency and can not be set-off against its interest. By comparison, a typical equity transaction entails a 0.5 percent stamp tax.
The convergence would occur as the interest paid on the long CFD equals the profit made on the stamp’s obligation. This hits that stage in 28 days – (0.5/1.0 multiplied by 365/6.5). This has to be changed to make it easier to pay the stamp duty on the conventional order three days after the contract’s date. Accordingly, the fusion takes place on day 25.
Consequently, it is commercially more profitable to exchange the CFD rather than the underlying stock for trades that have been pending for less than 25 days. The convergence point would appear sooner if interest rates increase past the 6.5 percent used in the example and later in the case of interest rate reduction. It is a simple estimate because of other factors. But the point is true for short-term or intra-day trade, although in the latter situation.
Diversity is crucial to CFD performance
Going short is an easy and straightforward tactic because whether the underlying price declines, CFD investing’s key benefits are to make a return. Such a position can be held indefinitely without constantly turning the position over, without the need or related costs. Long positions often produce an interest gain while dividends have poor payments.
Although there are no time limits on CFDs, most investors will use them for short- to medium-term trading or fund portfolios of physical stocks.
Most CFDs are closed in operation within three months, and the average time is around six weeks.
So it makes more sense to sell a CFD than the stock itself. You don’t actually need to have tens of thousands to enter the market, says Langham. ‘You can bring on an investment of £ 50 now if you like,’ he says. ‘Guys with £ 20,000 to spend will buy it in equal sizes. Somebody with £100,000 may get into some liquidity issues.’
Langham supports a range of trading strategies as the secret to a balanced portfolio. Irrespective of how much you have to deal with, you should look at all how CFDs can be used. ‘Liquidity is the secret, so I’d say foreign-exchange trade is definitely key to a successful trading strategy. We see a lot of activity in that area, and that’s where you’ll find the tightest spreads too.’
Langham goes on to explain the meaning of using CFDs from foreign currency as part of the trading strategy. ‘The foreign exchange has a solid margin of 1 percent. You have an advantage in that we sell it in 20 different indexes, so you will easily become accustomed to them. Most of these are 24-hour exchanges, so there’s still liquidity’. The true beauty in CFD trading is that you’re dealing for the most significant leverage.
Andrew Edwards, ETX Capital’s head of trading, has some very sound guidance about the approaches you can pursue around the industry, considering the advantages that leverage can bring. ‘For CFD and spread betting, the risk plan is the same.
Leverage is one of the main bonuses of both CFDs and spread betting. You can deal for much more than you invest. And I mean by that, don’t stick out too far. But with a relatively small investment, you can build a large portfolio
Angus Campbell says, ‘regardless of how much the interest element you want to invest, you’re going to use less of your money to invest. If you’re investing £100,000, you’re definitely going to invest in FTSE 100 shares. You will just need to use 10% to sell £100k of shares, leaving you £90,000 to spend elsewhere.’
Langham points out the advantages of leveraged investing and its risks. ‘If you are dealing with any size on margin, you want to be very careful of liquidity. You should be very well aware of how Level 2 operates. You could also consider playing the industries because instead of purchasing a significant amount of Vodafone or a considerable amount of Infineon or Microsoft, you can purchase the Us or British technology sector where you have better liquidity and the margins are 3% instead of 5%.
Trade-in pairs is another approach you can use to trading in CFD. An example of that would be if you believe in one business’s undervaluation relative to another – like Vodafone versus Mmo2 – you purchase the cheaper share when selling the expensive one. This approach reduces the market risk but helps you to leverage suspected short-term anomalies.
Langham says a smart approach has to focus on how much cash you intend to bring to the table. ‘It doesn’t matter too much when you deal in smaller investment amounts. Your investment choice may move 2 percent, so your overall position isn’t too big. But as you work with larger sums than £100,000, 2 percent starts to add up.’
The CFDs Big Picture
For a bigger sum like £ 100,000, Langham says you need to be mindful of a broader image before making the business push and be mindful of the currencies you’re using. ‘You should keep in mind what the global macroeconomic picture is. You’re looking for more of a balanced approach to the portfolio. Not only can you take the indices side of it and take a look if you like, but you should also look at the forex alternative. In CFDs, you buy American stocks effectively in US dollars. When you had to translate those back to pounds, there would be an impact, particularly with the foreign exchange aspect. In any important role you carry out, you will also weigh the implications of any forex trade.’
With liquidity Langham also indicates that the sectors are a good way to gain substantial exposure in the places you want without having to trade 10 times each time the usage shifts. ‘Bet you don’t want to gamble on the farm. You should be searching for a balanced portfolio, so you want many different tools and various types of tools,’ he says.
Hedging, going long or short or even both, the opportunity to lock up a profit on a physical stock investment, selling on a margin and taking advantage of the flexibility a CFD can bring, the ability to free cash from your regular stock trading account by moving your physical stock holdings to CFDs and, exchanging pairs, are among other techniques you can use to build a portfolio.
But don’t forget the losses on pause. ‘The use of halt and limit instructions is important for risk management. This provides invaluable functions for shutting loss-making places and taking profits at appropriate times.
‘However, one CFD vendor has been quoted saying that he thinks his most effective clients frequently use the platform’s order feature to reach and exit positions at self-selected, predefined thresholds.’