What are CFD strategies?
CFD strategies are trading techniques traders follow when buying or selling financial products called contracts for difference. These contracts allow traders to take advantage of rising and falling markets by making bets on future movements. As such, based on their speculations, traders can choose to profit from market upswings or downswings. However, trading CFDs is not as simple as it sounds. This is why it is always advised for beginners to practise their strategies on a demo account to check its efficiency.
A wide array of CFD strategies are available that suit traders trading at different timeframes and trading preferences. Some strategies are particularly popular for short-term trading, while others are better suited for traders who prefer holding their positions for longer periods.
Now, let’s dive into each category of CFD strategies in more detail.
Short-term CFD strategies
Short-term CFD strategies are used by traders who prefer to make quick trades without holding positions overnight. CFDs do not have specific expiry dates, which makes them ideal for short-term trading strategies like Scalping and Day trading.
The primary goal of short-term CFD strategies is to identify and capitalise on smaller but more frequent opportunities. Traders using these strategies aim to capture profits by carefully analysing price charts and using technical analysis to determine the best entry and exit points for their trades. These strategies require traders to stay focused and actively monitor price movements, allowing them to exploit short-lived market fluctuations.
- Range trading
A range trading strategy involves identifying specific levels of support and resistance in the market to determine when price reversals are likely to occur.
When a market is trending, prices tend to break above or below these levels. However, prices fluctuate between these support and resistance levels in a range-bound market, resulting in sideways movements.
For short-term CFD traders, range-bound markets present an opportunity to profit through scalping or swing trading. They take advantage of small price movements within the established range. Traders enter a position and hold it for a short period, aiming to earn a profit from the price move before it reaches a point of exhaustion or reversal.
- News trading CFDs
News trading is a popular short-term CFD strategy that takes advantage of the volatility created by economic announcements and news events. News trading strategies primarily target significant macroeconomic events, such as interest rate announcements and economic data releases. These events are usually scheduled in advance, making it easier to predict their outcomes instead of unexpected breaking news events.
Traders rely on a reliable economic calendar to effectively implement a news trading strategy. This calendar serves as a valuable tool for determining the timing of trades based on the scheduled news events.
- Hedging CFDs
Forex hedging is a strategy that involves taking positions on currency pairs to offset potential movements in other currency pairs. It is quite a simple process that begins with an existing open position, usually a long position, where the initial trade predicts a certain direction for the currency pair. To hedge, a position is opened that goes against the expected movement of the currency pair. This allows traders to maintain the original open position without incurring losses if the price movement goes against their initial expectations. While this approach eliminates the possibility of making profits during this period, it also limits the risk of losses.
Long-term CFD strategies
For CFD traders seeking longer-term positions, a combination of technical analysis and fundamental analysis is typically employed to gain a broader understanding of the factors influencing a market’s price. The trading style that aligns well with long-term CFD strategies is known as position trading, which closely resembles traditional investing. However, while investors may hold trades open for months or even years, traders tend to have a duration of days to weeks.
Long-term CFD strategies are more passive and trend-following in nature. They seek to enter trades at the beginning of a trend, or as close to it as possible, and then ride the momentum of the trend until it shows signs of reversal, at which point they exit the trade.
Here are some of the preferred CFD trading strategies commonly employed by longer-term traders:
- Support and resistance trading strategy
The support and resistance levels are areas representing the trader’s action. Resistance is where buyers are unwilling to push the price higher, and support is where sellers are reluctant to bring it lower.
While we have discussed the use of these lines in short-term scalping strategies, they can also be applied by long-term CFD traders, albeit on a different timescale. In a long-term approach, traders would open a long position at a known support level or a short position at a resistance level. They would then hold their trade until the prevailing trend reverses at a new support or resistance line.
Traders draw these support and resistance lines directly on their price charts using drawing tools. To confirm the validity of these levels, they often utilise momentum indicators, which help identify where a previous trend has lost its strength.
- Breakout trading strategy
A breakout trading strategy focuses on entering a trade when the price of an asset “breaks out” of established support and resistance levels.
In contrast to the previous strategy that involved trading within the range of these levels, breakout trading seeks to capture momentum as the price moves beyond these boundaries.
Typically, when a support or resistance level is broken, it signals the beginning of a new trend. Breakout traders aim to take advantage of this momentum and ride the trend in the direction of the breakout.
To effectively implement a breakout trading strategy, traders identify key support and resistance levels on their price charts. They then closely monitor the market for a decisive breakout, which is characterised by a significant move above resistance or below support.
- Pullback or retracement trading strategy
The pullback or retracement trading strategy involves taking advantage of temporary price movements against the prevailing trend. In a bullish market, a pullback refers to a temporary decline in price, while in a bearish market, it represents a temporary price increase.
By observing these retracements, CFD traders can identify more favourable entry points within an existing trend.
However, it is crucial to confirm that the movement is temporary and not a permanent reversal; otherwise, it could lead to being on the wrong side of a trade.
To determine whether a pullback is an ideal entry point or the start of a longer-term reversal, technical indicators such as Fibonacci retracements can be helpful. These indicators assist in identifying key levels where the price is likely to find support or resistance before resuming the overall trend.
When implementing a pullback trading strategy, traders closely monitor the price action and look for signs that the retracement is coming to an end. This may include observing candlestick patterns, trendline bounces, or momentum indicators showing signs of the original trend resuming.
Are CFDs good for the long term?
CFDs can be a viable option for taking a long-term position. Unlike futures and options, they do not have an expiration date. This means that if you have a profitable trade, you can keep it open for as long as you wish to maximise your potential profit.
However, it is important to consider the costs and charges associated with holding CFD positions. You will incur an overnight funding charge if you hold a daily CFD overnight. This charge represents the daily interest rate and is transparently published, allowing you to calculate your costs in advance. You can also use trading calculators to accurately calculate your potential returns and trading charges.
Alternatively, you can explore forward CFDs, which do have an expiry date but already include the costs of holding the trade for a longer period.
Why use a CFD trading strategy?
Implementing a CFD trading strategy helps you stay disciplined and avoid impulsive decisions driven by emotions like fear or greed.
By following a well-defined strategy, you can effectively measure and compare your trading outcomes against your intended plan. This allows you to assess your strategy’s effectiveness, identify improvement areas, and refine your performance over time.
A trading strategy provides structure and guidance, helping you make informed decisions based on predefined rules and indicators. It reduces the influence of short-term market fluctuations and allows you to focus on your long-term goals.
Moreover, having a clear strategy enables you to adapt to different market conditions, Whether it’s a trending market or a range-bound market, and adjust your approach accordingly.
Managing your CFD trading risk
CFDs are leveraged products, meaning you only need to deposit a small initial amount to open a position. However, your potential profit or loss is calculated based on the full market exposure of your trade. While this leverage can amplify your profits, it also increases the risk of substantial losses if your prediction proves to be incorrect.
Most traders utilise risk management tools like stops and limits to manage these risks. These tools allow you to set predetermined levels at which your position will automatically close, helping to protect your capital. These risk management tools can be attached directly to your position when you enter the trade, allowing you to establish your stop and limit levels from the beginning. It is important to determine these levels based on your risk tolerance and trading strategy.
By implementing stops and limits, you establish a predefined exit strategy for your trades, helping to protect your capital and prevent excessive losses. They provide a safety net and enable you to maintain control over your risk exposure in the volatile financial markets.