The idea of CFD trading has gained so much attention of traders across the world in last couple of years. The key to become successful in this venture is to follow a profitable strategy and be able to effectively manage your risk. Seeing that this type of trading has been generating lots of interest, it is critical to understand the basics of this exciting product and avoid the common mistakes so you get fruitful outcomes of CFD trading.
Common Mistakes in CFD Trading
Anyone can make trading mistakes including those who are the most experience individuals in CFD trading. Most of these mistakes come as a result of lack of planning, understanding or discipline. Although it is always vital to learn from your own mistakes, you must also learn from the mistakes made by others. Below are some of the most common mistakes that traders make when trading CFDs.
Unnecessary use of Leverage
One of the most important advantages of CFD trading is to access a financial product, such as a share or foreign exchange contract with a relatively small investment outlay. It allows you to enter into positions with a margin as low as 5 percent or even less, instead of paying for the full notional value of a CFD. Although you need to have a smaller capital amount to open the position, you will still be exposed to the price movement of the CFD for the full value of the position. A trader trading CFDs with 5 percent margin is basically leveraging their initial investment by twenty times, which further means that an amount of $5,000 could be used to initiate a position with $200,000 CFD.
Since a fraction of the value of the trade is spent when trading, even a small change in pricing can lead to considerable gains as well as significant losses. For example, when opening a position with a 5% margin, even a price increase of one percent in the CFD market can get you gains of 20 percent. Similarly, if price fells by 1 percent, it may also result in a loss of 20 percent of the capital needed to open a position.
In view of that, it is highly critical to remember that leverage in CFD trading acts as a weapon which not only can work in your favor but also work against you if you fail to manage it correctly. Most CFD traders ignore this fact and forget that unmanaged leverage can cause put them into significant losses.
Ignorance toward the Effect of Trade Sizes on the Account
With leverage factor in CFD trading, even small investments can lead to large moves in your overall account balance. If you buy 10,000 CFDs, for instance, at a price of $2.40 with a 5% margin, it will need an investment of $1,200 only. With this amount, you can open a CFD position of $24,000. If the price of this trade increases by 12 cents, it will make a profit of $1200. Similarly, if the price fells by the same, it will cause you a loss of $1200.
As matter of fact, the overall influence of any pricing movement usually depends on your account balance. For example, if you have an account balance of $2,000, the aforementioned deal can leave a considerable impact on your account profit and loss. For that reason, it is important to understand how the trade size can impact your account and make a deal accordingly. Doing otherwise in CFD trading can significantly put you in loss on your overall capital.
Choosing Large Trades
Successful CFD trading requires you to calculate the exposure of the trade size before you place it. Many CFD traders choose to trade large parcels available on the base of their account balance without even seeing the level of market exposure as to the position. CFD trading comes with various techniques to calculate a position size. And one of which is to determine an acceptable amount of risk capital if a trade fails and then calculate a suitable position size accordingly. Other ways can be assigning a fixed capital to each position, selling or purchasing a fixed amount of CFDs in every trade or changing the trade size according to the success of your account.
Overcoming the Mistakes through CFD Trading Strategies
Traders who have developed numerous trading strategies over the years are well acquainted with the challenges that emerge throughout this journey. First of all, you have to come up with a profitable idea and a basic understanding of how CFD markets operate and where the gainful opportunities lie. From a primary research, these edges usually exist in two different places, such as at extremes where the marketplace is either overbought or oversold. Here, a quick reversal can certainly lead to consistent profits.
The second area is to find profitable opportunities by integrating independent variables into your analysis. It is advisable to choose another variable other than pricing, such as volume, sector performance, market depth, company fundamentals, news flow or currency movements to make your decisions.
When getting involved in CFD trading, many traders tend to spend hours analyzing charting indicators into their software. It is worth mentioning here that most of these indicators are based on pricing and all of this analysis is about looking at prices in a diverse way. This makes it far difficult to achieve a breakthrough in profitability because you would only be looking at the same thing again and again rather than integrating newer data.
Below are some important tips to help you trade safely:
- Start small and minimize the leverage used
- Make a CFD trading plan that goes compatible with your personal profile
- Make use of stops consistently in order to protect your worst case situations by limiting the downside.
As a matter of fact, CFD trading can be best done with proper planning and effective strategies though it is somehow time taking to find a strategy that you are content with. It can in fact take hundreds of hours of online research, study, and computing time to come across a profitable trading strategy.