Here’s why you would choose CFDs over stock trading
As an experienced trader, you would probably be very familiar with trading strategies like technical analysis, fundamental analysis and quantitative analysis when deciding what securities to buy and sell. In fact, with the knowledge of all three strategies, you would be well placed to seek investment opportunities in other financial instruments like contracts for difference, or CFDs.
CFDs can be traded in very similar ways to other financial instruments like stocks and indices, following the same strategies. However, there are meaningful differences which allows CFDs to be utilised by investors in other unique ways.
CFDs are particularly suited for intraday traders who would typically trade in high volumes in order to gain returns from the small movements in particular stock. In such a situation, CFDs come in very handy given that the leveraged product would allow the trader to use a much smaller initial capital outlay to perform the same trade volumes.
There’s also the added benefit arising from the array of products that can be invested through CFDs, including forex, commodities and indices. An intraday trader can choose to trade in a market that happens to be trending on a particular day, all without switching to a different account or broker.
Furthermore, since CFDs can be used for long and short positions, an intraday trader would be able to fully maximise the price fluctuations, regardless of the direction it takes.
One particular technique often used by intraday traders is scalping. Scalpers plan to take profit on very small price movements, with some trades lasting just a few seconds. The idea is to make as many profitable trades as possible within a day, while attempting to minimise the possibility of losses with quick exits. The key lies in the speed of the entry and exits.
Bear in mind, that intraday trading is time consuming, and is a high risk trading strategy because of the trading volumes involved. Prices can turnaround quickly, and traders have to be very quick and alert to exit their trades before they make significant losses.
Another strategy commonly adopted by CFD traders is pair trading. The trader will pick two instruments that have a strong trading correlation – or trade in a very similar fashion to each other – and will hold a trading position on both of them, maintaining a market neutral position.
For instance, we take a look at two correlated stocks from the same industry like Pepsi-Co and Coca-Cola. If Pepsi appears to be under-performing and Coca-Cola over-performing, a pair trader might choose to take a long position on Pepsi and a short position on Coca-Cola, with the hope that their relationship returns to its statistical norm. This way, it does not matter which direction the market moves, the trader can still profit from the difference in price change between the two instruments, when their prices converge.
In some extraneous situations, the positive correlation may collapse entirely, leading to disastrous results, so traders must be aware of the risks involved.
This is an interesting strategy that takes advantage of the dividend payout date. While this trading technique is not unique to CFDs, it is made much more interesting because of it.
Dividend stripping is dependent on the trading pattern when a stock rises to price in an announced dividend payout, and then falls back to normal levels after the ex-dividend date.
CFD traders might opt to buy the shares one day before the ex-dividend date, collect the dividend, and sell the shares shortly after. If the shares are sold at a price that is on par with the purchase price, then the trader would recognise the full dividend yield. If a regular trader gets a 0.7% yield on that trade, a CFD trader who used leverage, would have recognised a yield closer to 7% (based on 10 times leverage).
Another way to dividend strip, is by purchasing the shares about one or two weeks ahead of the ex-dividend date, so that the trader benefits from the share price run up, and sells it before the ex-dividend date.
Yet another method involves both the above methods to benefit from the share price run up and the dividend.
Other ways to make CFDs work harder for you
Anecdotally, CFD traders have found other creative ways to use CFDs to their advantage. An investor who wanted to build up a portfolio of high yielding real estate investment trusts opted to use CFDs to acquire the units. While the investor used a tenth of the necessary capital outlay to acquire the portfolio, the yields from the REITs were also high enough to cover the CFD holding fees.
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This article was sponsored by IG, the world’s No.1 CFD provider (by revenue excluding FX, 2016). All views expressed in the article are the independent opinion of ZUU.