Trading CFDs (Contracts for Difference) is a speculative financial trading play that is not for the faint hearted. CFDs have been common place as over-the-counter derivatives in the Australian market for some time now, and they have a strong risk/reward profile tradeoff. To answer the question how to use CFD trading let’s look at where it can fit into your trading strategy as a trader or speculator.
Your risk profile
As a trader of CFDs, you need to be well versed in the fluctuations of the market and be prepared and set up to handle losses as well as ride gains. You’ll need to have a strategy for entry into and exit from the market, and be prepared to monitor your positions as they progress. If you’re unsure of some ways to determine when and at what price to enter the market, I suggest you immediately brush up on your technical and charting skills – see the technical strategies linked to from CFD trading strategies for some starting information.
If you’re a relative novice to trading CFDs, you’d definitely want to start with a demo account that is offered by most online CFD providers. You can hone your skills and theories here, just remember you’re likely to be more objective about imaginary funds than you would be when you actually come to fund an account.
Another possible strategy would be to mimic successful traders’ trades using a platform such as eToro, who have a feature known as CopyTrader (trademarked to eToro) where you can simply click a button and mimic successful and proven traders’ transactions. For more information, check out my review of eToro features.
Portfolio size and Diversification
Most traders when they look at how to use CFD trading will try to reduce their risk by only risking a proportion of their total capital or portfolio in CFDs. Again, the risks you are prepared to take depend entirely on your own position and tolerance to financial risk. It is possible to get diversification across asset classes within CFDs, as they are offered on the price change of a wide range of financial instruments such as market indicies, commodities and cryptocurrencies. However, as most CFD trades are held both long or short, in the time range of hours or a few days, it’s hard to see how diversification across asset classes really reduces risk (though I’m happy to be disproved on this, comment below!).
Suggested steps involved in starting CFD trading
1. Educate yourself as much as possible about CFDs and markets
This is crucial and can never be overdone. If you’re considering CFDs, you’re probably already familiar with financial markets and trading, so make sure you familiarise yourself with CFD terminology as well, especially leverage.
2. Open a Demo Account
You may want to test out a few different CFD providers, many of them allow you to register for free for a Demo account (check out my page here for more information on demo accounts and brokers available in Australia.
3. Choose a provider
From the Demo accounts, make a choice as to which provider you prefer. Factors such as software, spreads and support should all be considered.
4. Open and fund a live account
From the provider you have selected, open and deposit into your account. Most providers are fairly straightforward, though the deposit account normally has to be in your name (see this article on Plus500 minimum deposits for more info.
5. Have a strategy
Another crucial factor related to educating yourself – have a strategy and stick to it – check out this article for a more in-depth look at this – CFD trading strategies.
6. Zero in on a trade and execute (open, monitor and close your position).
It’s game time! Identify and execute according to your strategy. After familiarising yourself with a demo account the mechanics of this should be easy (the emotions and likely roller-coaster ride of CFD trading may not be though!).
Happy CFD trading!