What You Need to Know About Online CFD Trading
One of the fastest growing financial products in the last decade has definitely been Online CFD Trading, or what people refer to as Contracts for Difference (CFDs).
During 2004-2005, CFDs received incredible praise, as nearly all global markets were in the midst of a roaring bull market. As a result, traders were compounding their profits and the sky was the limit.
However, over the last handful of years, trading conditions have been a lot more choppy, especially when you consider the Australian share CFD market.
You can see in the monthly Aussie 200 index chart below just how choppy the market has been. Over the last couple of years, our market really hasn’t gained much ground.
So is Online CFD Trading Really just Gambling?
As with any financial product, you have the ability to trade it in a risk-averse fashion. Or you can be reckless and trade it with no clear trading plan or strategy in place.
Unfortunately, with a product like CFDs, which can be highly leveraged, there is little room for error if you trade without a plan.
Gambling is quite a strong word. But when you combine a level of leverage that makes it hard to sleep at night, a volatile market and a ‘hide-your-head-in-the-sand’ approach, then the results are unlikely to be positive.
Let’s just call this ‘pray and hope’ strategy as close to gambling as you can get.
Trading with excessive leverage is generally what we see time and time again as the number one culprit to blowing up an account (aka gambling).
Unfortunately, amateur traders will blame the product (CFDs) as the result of their large losses. Instead of their inability to control their emotions, trading without stop losses and trading with too much
Amateur traders rarely take full responsibility of their mistakes.
They would never blame:
- their inability to control their emotions;
- Relying on tips, punts and rumours;
- trading without stop losses; and
- trading with too much CFD Leverage.
Is it really CFDs that are the problem?
Sophisticated traders know that a product like Contracts for Difference (CFDs) are just like any other leveraged product, such as:
and as such…
need to be treated with care and traded carefully.
As with trading any leveraged product, you must control your account and minimise your worst-case scenario. A huge part of this is being proactive to limit your drawdowns.
What we tend to find with online CFD trading is the worst case scenario’s can be blown out of proportion and be a frenzy for media attention.
Journalist’s will jump on the band waggon, making calls to CFD Brokers and networking via the trading forum’s, to try and find those who have had a negative experience with the product.
It is then their job to highlight the losses those irresponsible traders had during their time trading CFDs. This then flows on to give a product such as CFDs a bad name and the moniker, a ‘gambling’ product.
Successful Traders Know They Need To…
If you want to enjoy a long life as a trader, you need to minimise the downside.
When you are on a losing streak with any trading instrument, you need to:
- Stay in the game by minimising your losses
- Trade well within your limits
- Use a position size which allows you to sleep comfortably at night
- Know exactly what major economic releases are coming out each week
- Never risk more than 1 to 2 percent of your overall capital on any one trade at any one time
- Have a robust trading plan which has been backtested and proven to provide an edge over time
- Use sensible position sizing models to help you achieve your financial objectives
- Trade in an emotionally stable frame of mind
- Be diligent about good record keeping and maintaining a trading journal
Suffering insurmountable losses or wiping out a small trading account is unlikely to happen if you have the character traits mentioned above.
But we see it time and time again where traders go-for-broke to make millions, trading CFDs with no thought about protecting the downside.
So is Online CFD Trading all that Bad?
The reality is trading CFDs give you the opportunity to leverage the cash you have in your account.
So with $5,000, you could trade total positions of $10,000, $20,000 or even $50,000, due to the leverage available with the product.
Just make sure you don’t get carried away. If you are not sure what the real numbers of CFD leverage are, then head over to our page on leverage to see our thoughts.
You will find these leverage levels are similar to both options and futures. But options and futures are considered more for the sophisticated trader.
One of the biggest benefits of trading CFDs could also be its biggest downfall
Trading Share CFDs is simple to understand and many of the complexities of options and futures are completely removed.
The ease for which people understand the product also means more traders are likely to get involved and as such, newbie traders and leverage start to mix. This is where we start to see the wild results and we see it both on the gains and the losses.
This is where we start to see the wild results and we see it both on the gains and the losses.
Remember, leverage is a double-edged sword and amplifies your wins and magnifies your losses.
Ironically, the major advantage of CFDs is the ability to pick it up quickly. But this leaves the door open to many newbie traders getting involved, when in all likelihood, they probably shouldn’t.
What Markets can you Access with Online CFD Trading?
Another of the key benefits of trading CFDs is the ability to trade many of the world’s markets, with little to no brokerage, all from the one trading account.
Markets you will have available at your fingertips include:
- Local share CFDs – up to 20 x leverage
- International share CFDs – up to 20 x leverage
- Global Indices – up to 200 x leverage
- Foreign Exchange (Forex or FX) – up to 400 x leverage
- Global Commodities – up to 200 x leverage
- Bonds – up to 100 x leverage
It is this global access which makes the product so appealing. But with any financial product, you want to make sure you know what you are doing before you jump in with serious money on the line.
The reason I showed the amount of leverage available is so you can appreciate what you can access as a trader.
This doesn’t mean you should be trading anywhere near maximum leverage. Otherwise, it will only be a matter of time when you will be telling people of your hard luck story trading online CFDs.
So should you be trading CFDs?
The final call has to be made by you.
But if you understand you:
- control the leverage;
- must have a sensible trading plan;
- need to use sensible risk management; and
- aren’t out to triple your account in 3 weeks
then CFD trading might be a reasonable option for your portfolio.
If however, you are not willing to spend the time:
- learning more about the product
- understanding leverage
- appreciating the risks involved
- building a robust trading plan
then perhaps you should stick to trading shares without leverage.
Online CFD trading is not a basic financial product, but it is not the scary, sophisticated product some journalist’s make it out to be.
Do your research and you might find a place for trading CFDs in your sensibly managed portfolio.