12 CFD Trading Tips to Help You Survive

CFDs are a useful financial tool that can help you achieve your trading goals in a user-friendly way. However, CFDs are not without risk, so we only recommend CFD trading to experienced traders. If you are a beginner, it is best to stay away from it. No matter what stage you are at, we have gathered 12 CFD trading tips for you to help you survive in the market.

In a nutshell, CFD trading is about speculating whether the value of a particular financial asset (such as a stock index, commodity or currency pair) will go up or down.

What is CFD Trading?

Before you start trading, it is vital that you understand what CFDs are and how they work.

CFD stands for contracts for difference – a derivative product that enables you to speculate on a range of global markets such as forex, commodities, indices and shares, without having to own the underlying asset. This means that you can take a position on rising and falling markets – you will go short (sell) if you predict the price will fall or go long (buy) if you predict the price will rise.

CFDs are a leveraged product, which means that you can gain access to a position by putting down a small deposit, known as a margin. Your profit and loss are calculated on the full size of your position – so its important to remember that while leverage can magnify profits, it can also lead to magnified losses, including losses that exceed deposits for individual positions.

CFDs started out as a type of leveraged equity swap in London in the 1990s, primarily used by hedge funds. By the late 1990s, CFDs found their way to the retail market as well, while the 2000s and 2010s saw the first exchange-traded and centrally-cleared CFDs, laying the foundations of dynamic growth. The UK's Financial Conduct Authority (FCA) estimated that the number of UK CFD brokers doubled between 2010 and 2016, and that UK clients held a total £3.5bn in their accounts. But that growth tells us only one side of the story. Because of the risks inherent in trading CFD contracts, regulators are becoming increasingly strict with CFD brokers. The Australian Securities Exchange closed its CFD exchange in 2014, while in some countries, such as the US or Belgium, CFD trading is banned outright. The European financial regulator, ESMA also introduced more stringent rules in 2018.

In the example below, you can compare the profit/loss effects of a no-leverage equity position and a 10:1 leveraged CFD position. You buy both the equity and the CFD when the underlying price (e.g. Apple share price) is $100.

Advantages of CFD Trading

There are four main differences between investing directly in securities and buying (selling) CFDs.

Lower transaction costs. Transaction fees may be lower in certain countries. For example, if you are a UK trader, you will not have to pay stamp duty as you would on a share transaction.

You can go short. It's much easier to ‘go short’ with CFD trading - allowing you to speculate that the price of a particular security will fall, which can otherwise be tricky or impossible for retail investors in most asset classes.

Broader market and product coverage. Due to the derivative nature of CFDs, issuers can offer a more diverse range of products, from single stocks to more exotic products such as cryptocurrencies.

Smaller transactions. You can usually choose the size of the CFD transaction, which can be as low as a few dollars. This may not be possible for the actual underlying product, which can have a minimum trade size of thousands of dollars. A good example is oil, where the standard futures contract size is 1,000 barrels, worth tens of thousands of dollars.

Use leverage. If you use leverage wisely, even small investments can pay off handsomely. Let's say you buy a $100 Apple CFD with 10% margin or 10x leverage (i.e., you only paid $10, and the remaining $100 of the price is leveraged). if the price rises to $109, you'll make $9, a huge 90% return on your initial $10 investment; whereas, if you'd invested $100 in actual stock, your $9 would only translate into a $9/$100 return. If the price rises to $109, your return will be $9, a huge 90% of your initial $10 investment, while if you invested $100 in the actual stock, your $9 will only translate into $9/$100 = 9%.

12 CFD Trading Tips

We do not possess a secret formula to successful trading, so you shouldnt expect our CFD trading tips to make you a millionaire overnight. But we do believe that the following points are worth keeping in mind if you want to avoid some of the common pitfalls of CFD trading and make the most out of the experience.

1.Use stop-loss orders

Rule #1: use stop-loss orders. Rule #2: use stop-loss orders. Rule #3: use stop-loss orders. If you want to hear our single most useful CFD trading tip, its this: make sure you limit your downside by using stop-loss orders, or even guaranteed stop-loss orders.

2.Use a demo account first

Before you jump straight into it, we suggest that you start with a demo account, offered by many online brokers. If you want to test our CFD trading tips free of charge before risking actual money, a demo account is a good place to start. If you open a demo account, it's a good idea to test it with an amount that you'd be actually willing to trade with in real life. In this way, you'll see more realistic returns and performance which can be both negative and positive. Do you have, let's say, $1,000 set aside for CFD trading? Enter this as a virtual amount in your demo account, start “trading” and see if you like the outcome.

3.Do your homework

Make sure you understand what you're doing, both in terms of CFD trading basics and your specific trading portfolio. So don‘t start trading before you know what a limit order or a market order is. Don’t try to trade forex CFDs before you understand the difference between a USD/GBP and a GBP/USD quote. And dont expect to become a specialist in all asset classes or all markets. It's better to pick a niche (or two) and stick with it.

4.Limit leverage

You can use leverage, but consider this: in most cases, it is unrealistic to think that the price will always instantly move in the desired direction after you opened a position.

5.Use the right trade position

Some brokers do not allow you to lower the leverage manually. In these cases, you might want to consider lowering your trade position. Whatever the case, always make sure you're aware of your outstanding risk exposure.

6.Do your own homework

Your neighbor, Wilma, is bragging about how much she made on Bitcoin trading. That doesn‘t mean she can repeat her performance; and it certainly doesn’t mean that you should jump right in and start trading Bitcoins like your life depended on it. First things first: read research reports, look up articles on the topic, and do your own analysis – fundamental, technical, or both.

7.Devise a trading strategy

Make sure you set up a strategy for each trade before you open it. For example, you should consider in advance where to close your position, in both best-case and worst-case scenarios. Think about potential scenarios of how your investment may perform. What happens when the underlying price goes up by 5%? What if it falls by 5%? 10%? 50%? You should think through how big a loss you can tolerate, or how big a profit you'd be happy with on that particular position.

8.Consider cutting your losers

Now comes the difficult part. If things go south, make sure that you don‘t start chasing your losses and that you remain committed to your initial strategy. You'll likely make the worst mistakes when you get emotional and want to “win back” what you've lost. Don't do that. Set out your rules and stick to them. For instance, if you decide to set your stop-loss 10% below the purchase price, then don’t deviate from this plan just because you‘re a massive fan of that particular stock and you’re convinced that eventually it will do well.

9.Leverage works both ways

Leverage is a double-edged sword - we can't stress this enough. By using leverage, you can invest more than you actually have. This is a nice feature for sure, but it requires a responsible approach. Leverage doesn't only amplify your gains; it also amplifies your losses. Are you prepared to lose everything in your account? If not, be careful with the leverage ratio you choose (if you're allowed to choose at all) and make sure you set the size of your trade position right.

10.Prepare for rainy days

There will always be days when your trading positions go against you, so always keep enough equity/cash in your account, in case you need to put up additional margin. Some brokers don't issue margin calls at all; they will simply liquidate some of your positions if you fall below margin requirements. This can happen precisely at the worst moments - so do your best to prevent it.

11.Dont put all of your eggs in one basket

CFD trading can give you access to a wide variety of markets and assets, so there‘s ample opportunity to diversify. And you totally should. So just because you think oil stocks are the next big thing, don’t go long in Exxon, Shell and BP plus crude oil at the same time. If you are proven wrong, youll be wrong big time, because these assets are all correlated and are likely to move in the same direction. And in a wider context: it's probably not wise to rely on CFD trading alone for a living. CFD trading can result in really volatile returns (or even big losses), so make sure this is not your only source of income.

12.Choose a reliable CFD broker

Having a good CFD broker can really make a difference in your trading results. For one thing, fees are very important. When you trade frequently, trading fees can carve out a big chunk of your profits. When trading CFDs, the most important cost is the spread cost: the difference between the bid price and the ask price. Make sure you find a broker that determines spreads in a way that doesn't eat up all of your trading results.

Available Markets and Asset Types

A good thing about CFDs is that they give you a wide range of trading opportunities. Whatever markets or asset classes you have in mind, chances are that you will find CFD trading opportunities for each. Just to name a few:

• Single stocks
• Forex
• Stock indexes
• Commodities (metals, energy, etc)
• Bonds
• Options
• Cryptos