Factors to consider when choosing a CFD trading strategy

4 months ago forexsimulation Comments Off on Factors to consider when choosing a CFD trading strategy

The emergence of the global financial crisis in 2008 saw a surge in trading, both retail and institutional. New algorithms were being developed to time the market, only to see it fail not long after. Algorithmic trading was blamed for exacerbating volatility in markets during the crash when some algorithmic traders had employed it to cash out quickly when volatility increased.

 

Many brokers are now offering their clients, beginner or advanced, the ability to trade on margin with highly leveraged products such as contracts-for-difference (CFD). These instruments allow investors to speculate on market price movements using barely any initial capital. However, CFD is an instrument that can be costly if your trades are unsuccessful, leaving you in debt. When deciding which brand of CFD to trade on, several factors should be considered.

Trading style

Know yourself and your investment style before opening an account with a broker. Are you a short term punter, or do you like longer timeframes? Do you prefer high probability trades or want to take on some riskier plays with the hope of significant gains? Most brokers will cater to traders with varied styles, but it is still essential to choose one that suits your trading personality and requirements.

Leverage

CFDs allow for highly leveraged trading. Some brokers offer 2:1 leverage, while others can go as high as 500:1. The higher the leverage, the more capital the broker will borrow from a client’s margin account to complete the trade, making a much larger profit on a slight movement in price. It means that you need to be very aware of your trading capital and how much leverage is applied to your positions. While very profitable, if things go wrong for one of these highly leveraged trades, it can quickly wipe out all of your funds.

Minimum initial deposit

Many brokers require a minimum deposit before allowing clients to start trading. In most cases, this amount is around $100 but can vary from broker to broker, so always check with them first to avoid disappointment. If the value of a position falls below the minimum required deposit, there may be no way for a trader to cover their losses and continue trading without closing the account with the broker.

Level of experience

It may seem obvious, but beginners should avoid potentially volatile instruments such as commodity CFDs due to their riskier nature and higher chances of failure. It also pays to do your research about complicated instruments such as global equity index CFDs, which have very high leverage levels, before trying them out for yourself!

Trade market depth

As CFD allows traders to bet on price movements in specific markets, they need to know what market depth is available before trading. For example, if you plan to open a long position of one lot on Apple (AAPL), it would be unwise to do so if only one or two lots of AAPL were traded at any given time.

 

You may open your position, but there may not be enough buyers or sellers willing to transact on your order, forcing you to wait until more liquidity is found and squeezing your potential profits. However, some brokers allow their clients to choose which assets they want on the platform, but these assets may not be the most popular and could cost traders more in terms of spread costs.

Service

A service is an impartial third-party that helps consumers resolve their problems with financial companies such as brokers. Usually, it is best to choose a broker endorsed by a well known and trusted service such as the Australian Financial Complaints Authority (AFCA) or The Financial Ombudsman Service (FOS) if things go wrong for you while trading on CFDs, having this kind of reputable service available can help.

In conclusion

When deciding which contract-for-difference instrument best suits your needs, many factors need to be considered. However, by knowing what kind of trader you are and being aware of the risks associated with CFDs, you will make the right decision.