Planning to trade CFDs? Here are some ways CFDs can boost your investment portfolio in volatile markets

Market volatility is a perennial concern of investors and traders. When you’re into trading or investments, it’s always a fair game. The probability of making a profit or loss is just about even. The market can be generous in terms of making profits and merciless when you get hit by losses.

But in a low volatility scenario, there are less trading opportunities. Hence, instead of sitting idly, traders seek out other ways to boost their investment portfolios. However, you need to have a deep understanding of the various markets. It also requires the ability to read future market movements before you can take on this leveraged instrument.

A brief refresher on CFD

The acronym CFD refers to a ‘contract for difference’ which is a form of derivative trading. It’s a popular form of trading in Singapore and across global financial markets.

CFD is basically a contract between an investor and CFD provider. The agreement enables the former to speculate on the price movement of a particular asset. There’s no buying or selling activity involved.

What is the primary objective in CFD trading?

Don’t be intimidated by the term because it’s simply a type of derivative trading that allows you to trade on both falling and rising prices.

For purposes of discussion, let us focus on CMC Markets which offers CFDs on a variety of global markets, for assets like currencies, indices, commodities, equities and bonds or treasury notes.

The primary objective in CFD trading is to be able to invest on the future price of an asset, without buying or selling a physical asset. As a client, you take a position on a chosen asset and invest on how you foresee its price to rise or drop on a set date. Your profit or loss is anchored on the accuracy of your prediction.

5 Ways CFD can boost your investment portfolio

Besides enhancing trading skills, investors choose CFD trading because it can work wonders to boost an investment portfolio. Unlike trading in the stock exchange with lower leverage, CFDs offer a higher leverage.

The beauty of CFD is that it can be an interplay of trading in both low and high volatility markets. Traders who can easily adapt to changing market conditions can develop their own strategic responses.

Limit your downside

The golden rule in CFD trading is using the stop-loss order to the hilt. By following this rule, you limit your downside. If you’re doing the regular stop-loss order, there’s a tendency to miss out on your stop price. That is also known as slippage, where prices move so quickly that the execution of your trade occurs past your stop-loss price.

To prevent that from happening, go for the guaranteed stop-loss orders. Your CFD provider guarantees that you get your stop price even if the price of asset price falls below it. The cost charged to you may be higher but regardless of circumstance, the CFD provider subsidizes the difference.

Some traders also found it effective to set stop loss orders closer to the trade entry point. It’s a way of mitigating risk while expanding your trading horizon.

Diversify to lower overall risk

CFD investing affords the investor the ability to diversify their portfolio. Because there is a wide breadth of assets, there’s an abundance of opportunity. Thus, sticking all the marbles on one asset class is not advisable.

Investors might feel intimidated investing in a volatile market, in spite of the opportunities that abound. The main weapon to overcome this scenario is to set a cap on trade sizes and keep the leveraging contained. The overall risk is lowered when you trade over various assets.

Otherwise, any wrong decision will only make it worse and compound losses. Venture into other assets when you’ve done your own fundamental and technical analysis. Remember that returns can be really volatile if your market reading is incorrect.

Protect and maintain your long-term portfolio

Investors holding long-term investments are threatened by short-term market swings during high market volatility. Losses are expected but can be arrested or offset by CFD trading.

In order to protect and keep their long-term portfolio, they use contracts for difference to ride on the short-term market swings and take advantage of them. Even though CFD is largely used for short term investment, some investors do also use it as a long-term investment instrument, depending on their investment needs and financial goals.

Use as an investment hedging tool

Many investors have perfected the art of hedging the markets using CFDs. Again, long-term investors benefit from CFD as an alternative to stave off losses during a market downturn.

For instance, you acquired 5,000 shares of an oil company at S$100 each. You bought them as a long-term investment because in a couple of years, their projects will come upstream and the value will double by then.

However, in a sudden twist, the stock price trends lower. If you’re still upbeat about the prospects of your long-term investment and acknowledge that the short-term price weakness is just temporary, you can instead choose to hedge your investment.

CFD trading can cover against further price declines in the short term. Whatever gains you derive from your short CFD trade can offset the paper losses on your long-term investments.

Do a dry run on a CFD trading platform first

It is always good to familiarize yourself with the instrument you are trading on, before you take on larger trades, and that can be easily done with CFDs. Most CFD providers offer a ‘free’ or trial account. Not because many are claiming it’s easy to make money in CFD trading, you jump without practicing.

The dynamism of CFD trading

Market volatility is a foregone conclusion. Every trader and investor is aware of its existence, whether it’s high or low volatility. Even major central banks institute policies to influence growth during low volatility periods. Unfortunately, they often result in unstable trading environments. Thus, CFD became the solution and an important volatility trading tool.

CFD trading brings dynamism and so much more on the table. First, it offers flexibility to address both short-term and short-term investment needs. Second, the product is uncomplicated but attractive for people desiring a diversified and safe portfolio. Lastly, it’s not exclusive to high-net-worth individuals or corporate institutions. Retail clients are given the opportunity to learn CFD trading and create or build wealth based on their own strategies.

The prospect of enormous gain is the temptation. However, you would need to be well-informed about the rudiments of CFD trading and the applicable risk management techniques. Keep in mind that when you deal with price fluctuations, it indicates instability. Therefore, while this type of trading is exciting, it’s also a risky business. A conservative trader won’t find CFD palatable.