There are plenty of reasons for traders to use CFDs. Sometimes, you can’t invest in the stock directly. Other times, you want to take advantage of CFDs’ leverage. However, there are two things that most people who trade CFDs don’t think about enough: money management and trading costs.
Money management is vital to any strategy because it helps you keep losses at bay while letting your winners run as long as possible. Whether or not you choose to trade using a mechanical system or not will probably dictate how successful you are with money management (that’s an article on its own).
Never risk more than 5%
The first trading rule is to never risk more than 5% of your portfolio on a single trade. However, this rule does not apply to CFDs. Instead of using stop-losses, traders can use CFDs to limit their losses on the market. While the 5% rule is suitable for novice traders, it is unlikely that they will turn a profit by sticking strictly with this rule.
Nevertheless, new traders always have just opened an account and are looking for safe ways to invest in the stock market without risking too much capital at once. For them, trading CFDs might be an attractive proposition as you can buy or sell shares without actually owning them. It means that instead of spending $10,000 on 100 shares of Apple Inc., you can buy CFDs with a margin of just $1,000.
When trading CFDs, it is important to understand the risk-reward ratio. It refers to how much profit you stand to make compared with the loss from your trade. Imagine that you invest $1,000 into 100 CFDs at $50 each (the value of one CFD). You then see that price fall by 5% and sell accordingly for $45 each; since there are 100 shares in total, this means an overall loss of $500.
Trading costs essentially boil down to brokerage fees and spreads – the difference between the price you want to buy and the price you sell. Of course, there are other things, such as exchange fees, but these add up to a tiny portion of your costs.
As such, you mustn’t get caught out paying high trading costs. There are some easy things that you can do before even opening any trades:
Ensure that your broker offers competitive rates and has no hidden fees (some brokers may offer lower spreads than others). Opt for longer expiry dates, so brokerage fees decrease (representing a more significant deal size). Look out for special promotions and deals from your broker so you can get more value. Sign up with rebate traders or brokers who offer rebates if you generate enough commissions for them.
Do your research
There are many different brokers out there to choose from. Ensure that you do your research to get the best deal available. Also, don’t forget to factor in other costs such as spreads and commissions when purchasing CFDs. Compare this cost with other investing methods that produce higher returns to see if it’s worthwhile for you or not.
With these precautions in mind, trading CFDs is relatively straightforward. However, traders should always be wary of their greed – being overconfident could result in devastating losses due to poor money management decisions! As a general rule of thumb, most people should only trade using no more than 1-2% of their total net worth/income because it will wipe them out quickly. Keep this number in mind when trading, and you should be fine.
Many people make CFD trading seem more complicated than it is. The important thing is to do your research and manage your money well by keeping the costs involved with trading. As long as you’re doing all that, then there’s no reason why you can’t have a successful career in CFD trading!