The best CFD trading strategies and pro tips for beginners and seasoned traders
One of the most commonly used trading instruments, Contracts For Difference (CFD) are present on different markets: stocks, bonds, cryptocurrencies, forex, etc. This is a great option for both starters and seasoned investors, but before you plunge into trading practice, you should be aware of efficient strategies and rules of risk management. In this detailed guide, you will find all essential information about CFD trading for beginners.
What Is A CFD Trading Strategy?
CFD (Contract For Difference) is a financial derivative product that allows traders to make profit on price fluctuations of different assets, such as stocks, shares, commodities, forex and cryptocurrencies. It’s not obligatory to buy the asset itself, though.
What makes CFD trading strategies differ from the tactics applied to other assets?
The main difference between CFDs and currency pairs is that CFDs are more like futures. Trading contracts are also carried out through leverage. But while in currency pairs traders can use the proportion of 1:200, 1:500 and even 1:1000, on CFDs, this difference will rarely exceed 1:50. This instrument requires a completely different money management approach and comes with another risk/profit ratio.
Secondly, trading CFDs and currency pairs differs in the fundamental factors necessary for market analysis. In technical analysis, there are no differences between assets. Whether it’s EUR/USD or Google stocks, chart patterns or candlestick patterns will show up in the same way. But when it comes to fundamental analysis, only a certain layer of statistical information will affect the dynamics of the instrument.
Lastly, volatility for CFDs and other assets is different. CFDs are considered to be more responsive to fundamental changes. The issue of volatility is very important for speculators. The greater the amplitude of movement, the more profit they can get. With respect to CFDs and intraday forex strategies are popular among traders.
And finally, CFD trading is usually dependent on the opening hours of exchanges, while forex trading is carried out around the clock.
Why trade CFDs?
CFDs can be used by traders both for speculative purposes and for hedging. Trading CFDs does not require a large initial capital and can be done using broker’s borrowed funds (margin). The amount of margin that the broker will provide you with depends on the amount of leverage.
Since the conclusion of a CFD does not imply the transfer of shares ownership, there is no need to pay stamp duty. In addition, the conclusion of CFDs comes with minimum margin requirements and savings on various kinds of depository fees (associated with the registration of the transfer of ownership of securities).
Currently, it is possible to conclude CFD contracts for the following main types of financial instruments:
- Stock Indices
- Interest rates
- Currencies (forex)
Thus, CFDs give traders enough flexibility and are present on many markets, not to mention the low entry threshold thanks to a leverage. At the same time, the latter condition means you should practice risk management. This can be challenging for starters.
Advantages and Disadvantages of CFD trading
Benefits of CFDs:
- The ability to trade with high leverage, which gives the trader the opportunity to increase profits.
- Availability for the majority of traders (with almost any capital on their trading accounts). While purchase of real assets requires hundreds or even thousands of dollars, a CFD contract for the same asset can be purchased with a smaller sum.
- Low commission (frequently, brokers limit themselves to only taking only the spread for their services). There is no need to pay all the costs associated with the execution of ownership right transfer, no matter which asset underlying the CFD is used (since no transfer of rights actually occurs).
- Great selection of tools. Today, you can trade CFDs on almost any asset listed on the stock exchange, commodity exchange and the Forex currency market. Many brokers are introducing cryptocurrency CFDs, as well.
Drawbacks of CFDs:
- Leverage can be both an advantage and a big disadvantage due to the fact that it greatly increases trading risks. Beginners are not recommended to trade with leverage of 1:10 and higher.
- There is also a risk that the counterparty of the transaction will not fulfill its obligations. However, this risk is almost completely eliminated when one works with CFDs on an official exchange market (in this case, the exchange guarantees fulfillment of all terms in the transaction).
- When buying a CFD on a certain asset, the trader does not reap the benefits of its possession. For example, when buying CFDs on shares, he cannot receive dividends on them (since he does not actually own these shares).
How CFD Trading Strategies Work?
An experienced CFD trader will tell you that a strategy should include:
- Entry conditions
- Trading time frame
- Risk management tools
- Stop loss planning
- Exit point
There are many ways to determine an entry point. You can use moving averages, trend lines, chart patterns, candlestick patterns, support/resistance levels, a multitude of technical indicators and many more. Moreover, possible combinations of these tools are endless. Additionally, you can incorporate fundamental factors by analyzing economic indicators.
Some people think that a reliable entry is the most important thing, but in fact, it may be one of the least important aspects of a good strategy. You can actually make a profit with a success rate of more than 50% provided you have an effective money management approach.
Risk management tools
It is essential to define your risk appetite. This level of risk must be adapted to your personality so as not to affect you psychologically in the event of a loss. If you lose too much money on a trade, you may need to increase the risk to recover. This mistake is very common among beginner investors. Thus, before winning, you must learn to lose as little as possible and stick to reasonable guidelines.
The maximum loss on each trade should be calculated as a percentage of the account or in cash. You should also define a maximum daily loss and stop trading for the day when it is reached.
Placing the stop loss is probably the hardest part of building a trading strategy. Some traders do not use protective stops on all their deals, but it is very risky. Stop loss placement should be an integral part of your strategy.
Without this tool, you will always be tempted to wait a bit longer for the asset’s price to go in the expected direction. As a result, you can lose a lot of money if the market trend suddenly changes. Absence of a stop loss is a sure sign that you are trading based on your emotions and not your strategy.
There are a few basic methods for deciding when to close a trade:
- You can exit at the point calculated using various technical tools including Fibonacci retracements or chart projections, support/resistance levels and many more.
- As an alternative, you can decide to take profit on a certain number of pips using a risk/reward ratio. For example, if your stop loss is placed at 30 pips, the take profit will be at 60 pips.
- You can also use a trailing stop to take a big trend or take half of the profit and gradually increase the stop for the other half of the position. All of these methods have their advantages and disadvantages.
Top CFD Trading Strategies
Below, we discuss the most commonly used trading strategies for CFDs, but there are many more than that. Depending on the time frame and risk/profit ratio, you can pick some of those or use other approaches.
One of the most widespread CFD trading strategies, following the news means keeping tabs on economic events and announcements, many of which happen according to a calendar. That will help you perform fundamental analysis of the underlying asset.
With this approach, you can try two CFD trading strategies: buy before the release or after. In the first case, you should be able to predict reactions to the news. This way is recommended for experienced traders who know the market and trading psychology well.
In the second case, you can make decisions according to the market’s reaction, which is easier. However, you still face risks because prices can suddenly change. This is why setting stop loss and take profit is crucial for securing your capital.
Technical Analysis Trading
Technical analysis is a must for any trading strategy, but there is a myriad of options and combinations of indicators and graphic tools.
During technical analysis, you study price charts and historical data to make predictions for certain time frames. The key to successful trading here is to analyze past trends and make correct assessments over the future ones.
Day traders study day charts (15M, 30M, 1H), but if you opt for long-term investments, you should watch monthly and yearly charts. While observing price charts, use indicators - they will help you find patterns and trade reversals based on support levels, price highs and lows.
They say ‘Trend is your friend’ and this is completely true for CFD trading, too. Trend lines are easy to distinguish and draw. You should activate some indicators to see where the price is going and predict market trends (or their absence).
As a rule, a trend line is drawn as a straight line between two points on a chart. When this line is touched three and more times, you can see a validated (or active) trend. Aside from classic indicators (MACD, RSI), traders use oscillators that display overbought and oversold market conditions. That allows predicting whether trends can reverse at any moment or will continue.
This is a commonly used strategy for stocks, but can also be exercised with currencies and commodities. It is applicable to both low-volatile and high-volatile markets, and price direction does not matter.
Pair trading with CFDs has the following peculiarities:
- A trader buys two CFDs within a single industry, one with a long position, another - with a short.
- These two assets should have correlation in price movements. Initially, they should have a high correlation that starts getting lower. Traders take advantage of the divergence in asset’s values.
- Before opening, decide which asset is weaker and which one is stronger. Open a short position on the strong asset, and a long position on a weak asset. The direction of the market does not matter because you will win on one position while losing on another.
What’s the profit then? Traders get it from the relative movement of the assets. The higher divergence, the more they earn.
Hedging is a bit different from other approaches because it’s aimed at protecting your funds. The strategy should be exercised with a well-diversified portfolio of CFDs or stocks that you’ve been holding for a long time. Such capital saves them from losses caused in price drops.
For example, if you hold stocks of Johnson & Johnson company and believe that the market will face a downtrend but don’t want to sell your stocks, you can open a short position on a CFD for this asset. Thus, you can benefit from short-term price drop without getting rid of the stock. As a rule, hedging is used as a complementary activity to your basic CFD trading strategies.
Here, your major goal is to find trending markets. You should find assets that are moving in a particular direction, especially the ones that may have serious price fluctuations within a short time.
This strategy is exercised together with technical analysis. Different indicators, such as MACD, RSI, and oscillators are of great help. Don’t forget about analyzing support and resistance levels, as well as stop-loss and take-profit settings. Oscillators may show you the price peak and moments when the trend is about to reverse - that will allow you to react proactively.
CFD Trading Strategies For Specific Assets
Each asset has a few peculiarities, such as the level of volatility, correlation with other stocks and economic news, seasonality and so on. That’s why you should craft your CFD trading strategy accordingly. Let’s review a few examples.
For trading oil, it’s recommended to use the combination of CCI and RSI indicators: it will help you define whether the asset is overbought or oversold. Thus, oil is traded in cycles.
Here is step-by-step instruction for trading oil:
- Look at RSI and define whether it shows an overbought condition over a long period - this is a sign of a bullish market.
- Now, wait for market reversal when RSI drops down and displays an oversold condition.
- To confirm the bullish period, make sure that the CCI indicator stays above zero (better above 100). When these indicator conditions coincide, you can go long on the CFD.
Don’t forget to use protective instruments. Check asset value and find the level at which it will be oversold and put a stop-loss. Exit the position at the end of the day or when the CCI indicator gets below zero - this displays a new cycle.
CFD trading on oil will depend on the balance of supply and demand in the market, OPEC decisions, the dollar exchange rate (with all the ensuing branches) and global economic indicators, as well as the main consumers, primarily China.
Momentum trading is also applicable to CFDs, which means you can identify a trend and open a position at the right moment. Indices are perfect for this strategy because of their high liquidity.
In mechanics, this trading strategy is similar to the news strategy. When you expect an economic announcement that may trigger short-term volatility, you should identify the right entry points depending on what position you’re going to open (for example, start with a short and continue with a long when the market stabilizes).
For gold trading, you should study historical data. This asset follows a strong yearly trend with the price swings witnessed in January, February, August, September, November and December. This is when it’s recommended to purchase gold CFDs.
If the price of gold in January keeps near the support level, you should go long. If it fluctuates, wait for the break of the resistance level. Put stop-loss below the last low swing. Now, you can keep the CFD until the end of February or until it generates profit. Don’t forget to move stop-loss accordingly.
You can exercise almost any CFD strategies with stocks. For example, if you’ve got a diverse portfolio, hedging can be the most profitable. If you prefer low risk, try pair trading - the direction of prices does not matter.
How to get started with a CFD trading strategy
Follow these steps to craft your own trading strategy:
- Open a trading account with a broker. Then you should deposit funds and trade on live markets, but if you are a beginner you can try a demo account to practice with virtual money.
- Learn the market and study CFD trading essentials. You should know about different strategies and best practices to compare them and choose a suitable option.
- Choose CFD instruments. You can select from shares, forex, commodities, indices, treasuries, ETFs and our exclusive share baskets.
- Decide upon your strategy. You should understand what sort of positions you want to open - short or long.
- Choose the preferable risk/profit ratio and risk management tools (stop-loss and so on).
CFD trading tips
Now, as you have a ready trading strategy, you should keep in mind recommendations from trading experts and seasoned investors. They will help you avoid mistakes and minimize risks.
- Stick to your CFD strategies. You should have a certain set of rules that you always follow. For example, you can trade at certain hours, always use a stop-loss and exit positions that don’t correspond to certain conditions.
- Know your limits. It’s important to put a certain percentage of your capital at stake. Do not put all eggs in one basket - diversify your portfolio. It’s important for risk management. Experienced traders don’t recommend spending more than 2% of your funds on a single deal.
- Raise your knowledge of CFDs and the market in general. You should know their peculiarities to build efficient strategies.
- Keep track of your positions while using technical and fundamental analysis.
- Don’t copy another person’s strategy just because that trader is making money, the strategy should match your trading psychology.
We have already mentioned some tools that help traders harness their risks and minimize losses.
First, CFD trading comes with a leverage which allows you to borrow money. Although it can help you earn more money, you also face higher risks. Margin trading done by inexperienced hands can turn into capital loss. If you are a beginner, better postpone experimenting with leverage. Study the market first.
Always use a stop-loss. Otherwise, if the market goes in the wrong direction, you may be tempted to keep your CFD position until the price rebounds. This way, you risk losing both your capital and your time. It’s better to exit a losing deal and open a new one or take a break during market turbulence.