Long and Short CFD Trading

Long and Short CFD TradingA well rounded investment portfolio will contain a diverse mixture of financial instruments.

Whether this portfolio is conservative or aggressive, different investment sectors, such as bonds, stocks, futures, options and currencies provide long-term stability in the sense that one sector going through a rough patch will be offset, hopefully to a greater degree, by another sector gaining value.

Once this diverse portfolio is secure, a small portion of the profits it generates can be earmarked for more aggressive financial instruments, where an investor can generate rapid equity growth by correctly anticipating the gain or loss in value of an individual stock, stock index, commodity or currency. Yes, whether the market is bullish or bearish, you have the opportunity to build your assets through certain investment vehicles.

One of the most recently developed ways to participate in financial market speculation is Contract For Difference (CFD) instruments.

In CFD speculation, a buyer and a seller enter an agreement that the buyer will pay the seller the difference between an asset’s current value and its value at a future point in time if, when the buyer decides to relinquish control of that asset, its value is below the original purchase price.

On the other hand, if the value of the asset has increased when the buyer decides to liquidate, the seller must pay this difference to the buyer. The contract may be with another individual investor or with the CFD broker directly.

The primary distinction between CFDs and more traditional investments is that it is very easy to participate in the opposite direction, that is, selling an asset that one does not own and buying it back at a later date and lower price to capture profit. In this scenario, the seller, upon deciding to give up control of an asset, will pay the buyer if the asset has increased in value beyond the price established at contact origination.

The chief advantage CFDs possess over futures and options is that the contracts do not expire and thus experience no time imposed decay in value. In effect, the CFD participant does not have to contend with the frequently moribund price activity a futures or options contract will experience close to the contract expiration date.

Another important advantage is that CFDs are traded on margin, meaning that a small deposit can control a much larger asset. This makes this form of investing accessible to the average investor who might otherwise not possess sufficient capital to participate by purchasing or selling an asset outright. This leverage is also responsible for CFDs being inherently much more risky than traditional investments, so careful consideration is necessary to determine one’s suitability, both financial and psychological, to this type of investing.

Simply stated, high potential rewards = higher risk.

If it has been determined that CFDs will be some part of an investment portfolio, some strategies for employing them are necessary.

In its simplest, purest form, this strategy can be expressed by two sentence fragments: 1. Buy low, sell high; 2. Sell high, buy low.

Exactly how and when to do this is the trick that has occupied the total attention of investors since the time Jack traded his mother’s cow for some magic beans, and before. There is no shortage of “experts” who, for a price, will reveal to you the secret of when to buy and when to sell, thus enabling you to obtain fabulous riches and live a life of luxury and leisure.

Listen carefully to these experts, however, and notice how almost without exception, the words perhaps, maybe, should, could, may and would enter into their statements and predictions. Then ask them, or yourself for that matter, the key question underlying all this: If you or I had an infallible way to determine whether the future price of an asset would increase or decline, why in the name of all that is precious would you or I sell or otherwise reveal it to anyone?

Strategies for determining the future values of an asset are practically infinite in number and have been the subject of exhaustive, voluminous analysis since investing first originated. An extremely complex strategy, one based on excruciating analysis of historical data, mathematical formulas and the current environment is no more assured of success than is the most basic one. In fact, if in your mind, the advantages of CFD investing outweigh the disadvantages and risks, sign up for practice account with a CFD broker and explore the strategy that is best suited to your risk tolerance and temperament. Knowing yourself and what works best for you is paramount in forming and using any particular strategy. Here is one of the simplest CFD trading strategies to try.

Observe the direction prices are taking. If they are consistently going up, with higher high points and higher low points, an uptrend is present and the investor should buy, or go long.

If the opposite is apparent, with prices making lower low points and lower high points, a down trend is occurring and the investor should sell, or go short.

The advantage of this simple strategy is that prices tend to continue in their current direction. The disadvantage is that no one, repeat no one, knows when prices may reverse and go in the opposite direction. The proper tactic for using this strategy, should you find the trend has reversed just as an entry has been made is to Get Out Now!

If on the other hand, prices continue to trend in the direction you’ve chosen, let that trade run until it begins to fail to accumulate profits. If your position was long, look for a place where prices have repeatedly been unable to move higher. This area is known as resistance. If your position was short, and a down trend continues, look for a price level that has prevented prices consistently from going lower. This level is called support.

The other half of this strategy is this:

In an apparent uptrend, when it appears that resistance is in effect, sell.

In an apparent downtrend, when support is evident and prices refuse to go lower, buy.

The advantage to this tactic is that when selling at resistance or buying at support, if a trend resumes, it will be very obvious and that trade can be closed with minimal losses. The disadvantage is that prices frequently hover around support or resistance for indefinite periods of time, making it difficult to ascertain whether a trend will resume or reverse.

Practicing CFD trading with this simple strategy will provide great insight into both your suitability and preferences, which is ultimately the primary factor that will determine success or failure. As you gain familiarity and experience with this strategy and CFD markets, experiment with variations to build a custom strategy for yourself.