5 Tips on Choosing the Right Type of CFD Trading
Contracts for difference (CFDs) are an exciting and flexible way to trade in an enormous range of financial markets. It’s a type of trading where you bet on the price movements of different financial instruments. These instruments can be stocks, gold, commodities such as oil, cryptocurrencies like Shiba Inu, fiat currencies such as the US dollar and the euro, and many more.
You make the bet by opening a contract with another CFD trader for a certain financial instrument. When the contract closes, you exchange the difference between the opening price and the closing price. If you guess correctly, you earn a profit. So, it’s important to get it right.
Opting for the Long Position
A long position means you think the price of something will go up. You buy something now (while the price is lower), and sell it later (when the price is higher). This is the most intuitive and common type of trading. It can be highly effective, after all, Warren Buffet became a billionaire by only opening long positions.
With CFD trading, this means you will buy the number of CFDs required to open the desired long position. You can use leverage to open a long position that’s larger than the money you put down.
Opting for the Short Position
A short position is the opposite of a long position. It means you think the price of an instrument will go down in the future. To profit from this price movement, you need some way of selling the instrument now (while the price is high) and buying it later (when the price is lower). This might seem counterintuitive, but it’s trivially easy to do with CFDs.
Keep in mind that short positions have a higher risk of losses than long positions, especially in the stock market. If the price keeps going up, so do your losses. Short positions are how some hedge funds lost billions betting against Game Stop.
Long & Short CFD Trading: What’s the Difference?
Here’s how opening a long position vs. a short position might look. The example shows the two positions on a $30,000 trade with 10:1 leverage, with a $10,000 price rise or fall to give you a profit.
Note the differences in fees, interest, and net profit once the trade is closed. Fees will depend on your chosen CFD platform, and you should know them well.
|Long Option||Short Option|
|Leverage (margin)||10:1 (10%)||10:1 (10%)|
|Fee CFD Position (open)||$300||$300|
|Fee CFD Position (closed)||$310||$290|
|Profit – gross||$10,000||$10,000|
|Interest subtracted (long)||$514||–|
|Interest added (short)||–||$470|
|Profit – net||$8,866||$9,890|
5 Tips to Embark on CFD Trading
When you’re just starting with CFD trading, there are a few principles you should know that will serve you well in your trading career. Follow these tips and you’ll be sure to get off to a good start, and maintain your momentum going forward.
- Start With a Demo Account: It can be tempting to dive right into trading with real cash. Especially when you have the excitement of just signing up and you’ve just learned some new trading strategies. But, this is a bad idea. No matter how much you research, you’ll still make some basic mistakes as a beginner. You’ll make bad bets, mistime things, and will likely use trading tools incorrectly. Start trading with a demo account (a.k.a with fake money) to test the waters. When you’re confident with the interface, markets, trading tools, and with your strategy, start trading with real money.
- Know All the Flaws of CFD Trading in Advance: CFD trading comes with a host of risks. This is true of all trading, but some particular risks are accentuated with CFD trading. You have no investor protections compared to owning securities, and there can be extra costs involved in holding certain positions overnight after 5 pm. Leverage is also a key risk multiplier you need to manage well.
- Never Stop Learning: When you trade, you’re in a global competitive game with millions of other traders in the world. Nothing stays the same for a long time. The only way to achieve sustained success is to keep learning every day. It may be learning more deeply about the structures of a certain market, or researching more companies or trading strategies. Everything you learn will give you a sharper edge against the competition.
- Use Stops and Limits: Stop and limit orders will be your saving grace and keep you in the trading game through your mistakes if you use them correctly. If you don’t, you’ll eventually get wiped out when you don’t expect it. Stop-loss and limit orders are a must on pretty much every trade you make.
- Don’t Chase Losses: When you incur a big loss, it can be tempting to make another risky bet in order to cover your defeat. This is a bad idea as repeating this strategy will likely lead to losses so bad you end your trading career. A better strategy is to protect yourself from big losses with a risk mitigation strategy. When you do lose, accept your losses for what they are and move on calmly and rationally.
The flexibility to quickly open short and long positions makes CFD trading attractive, as you can profit in a rising or falling market. If you can develop your trading strategy and manage the risks involved, it’s possible to have consistent success. Just remember, start with a demo account to test out the different types of trades. Never stop learning, and have fun!