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NOT TREATING CFD TRADING LIKE A BUSINESS

Embarking on CFD trading without having first formulated a trading plan is like starting a business without first devising a strategy for its growth. In order to succeed in CFD trading, you need to construct a clear set of principles and rules guiding your trading, taking into account your disposable capital, trading goals, timeframe/availability and trading style (i.e. aversion to or proclivity for risk). Perhaps most importantly, you need to know which risk management methods you will employ in the (likely) event of a mistimed or miscalculated trade.

When creating a business plan, you need to be asking yourself questions like why are you trading? What percentage return do you expect? How much can you afford to lose? What products will you trade? Many CFD traders fall victim to a ‘Jack-of-all-trades’ mentality by trying to master shares, FX, commodities and indices all at once, but the simple truth is, CFD trading is complex enough as ;it is without introducing new variables. To be successful in CFD trading therefore, start by formulating a trading strategy that centres on a product you already know.

View your trades as business transactionsQuestion your business plan from different anglesSpecialise in a product

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Stop-losses help in the long-term

NOT USINGSTOP-LOSS ORDERS

Building stop-loss orders into your trading strategy is a fundamental rule for successful CFD trading. It’s worth remembering that, even if your trading style takes a longer-term view on positions, you can use a wider stop-loss level to help safeguard your funds. That is to say, you don’t necessarily have to limit your profits by stopping-out positions early, you can simply widen (or tighten) your stop-loss levels in accordance with your trading style/strategy. There really is very little excuse, therefore, for avoiding the use of stop-losses. Try not to think of stop-losses as a nuisance, but as just another part of the trading process.

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It’s easy to be taken in by impressive leverage quotes, but large exposure for a comparatively small investment can be a double-edged sword, especially in CFD trading terms where the risks can be higher than other trading options. This is the basis of another mistake that has been the ruin of countless CFD trading accounts, so let’s look at how you can reduce the risk of over leverage. The best way to think about leverage is in a working example. Let’s say you have a CFD account size of £10,000. You choose to buy 10 contracts on the FTSE100 at £10 per point while it sits at 7000. The value of your exposure is now £700,000. Now, if the FTSE drops by 1%, your loss will be £9100, which is almost the entire size of your account. If you’d have lowered your leverage however, you’d have allowed for some flexibility in the (likely) event of sharp market movements, and, whilst reducing your potential profit, you would have dramatically reduced your risk of losses exceeding your deposit.

UNNECESSARYLEVERAGE RISK

Lowering Margin gives you flexibility in sharp market movements.

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Due to the involved risk in CFD trading, it’s easy to fall victim to rash decision-making based on hunches and ego struggles, but the truth is, you need to remain objective and impartial at all times. This means listening to the movements in the market rather than your gut instincts. For most traders, this is a tough habit to break, and understandably so; we are used to being told to follow out instincts. The main thing to remember is that the most successful traders share in maintaining a self-critical eye, and so should you.

Part of self-appraisal is recognising when you need to take responsibility for poor trades. So, when the market inevitably does move against you, accept the movement on face value and adjust your position accordingly. Too many traders fall into the trap of pouring more and more money into a losing trade in the hopes of riding out the downward turn. Even if there’s a turnaround, the price will naturally have to rise higher than your original position in order to turn a profit, which could take a long, unprofitable time. Don’t be afraid to cut your losses and reposition yourself in a safer position on the market.

PRIDE

Be aware of your emotionsRecognise your poor trades

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This is a mistake made by most traders, regardless of their experience on the CFD markets. Keeping some form of record or diary in which you can document and review your trading actions and outcomes is one of the best (and free) ways of improving both your chances of success, and the speed with which you take to the markets.

We mentioned earlier that successful traders treat their trading as they would a business. It should come as no surprise then, that many of these successful traders adopt the common business practice of recording and reviewing their actions, outcomes and learnings following the end of a trading day. Developing a self-critical approach to trading this way will stand you in good stead for building and maintaining a sense of objectivity when it comes to future trading decisions. Furthermore, you’ll likely find that keeping a trading diary helps you to reinforce your learning of the markets, because you are reminding yourself of both expected and unexpected movements that (rightly or wrongly) influenced your trading plan.

Most importantly, you’ll pick up the skill of analysing your own trading style, which will lead to an understanding of your strengths and weaknesses. This is invaluable because your trading strategy is as much about your ability and tendencies as it is about any other factor, so building your character into your strategy through an impartial analysis of the trades you make is going to prove beneficial in the long run.

A trade record can improve chances of successDevelop a self-critical approachAnalyse your own trade style

Takeaways

NOT RECORDINGYOUR TRADING ACTIONS5

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In the same vein, it’s incredibly easy to be tempted to continue throwing money at a trade that continues to lose. The fact is, if you aren’t careful, you’ll have dug a hole that only a monumental rise in the market can rectify. Try and think of it as follows, if the price point drops by 30% and in response you buy more because you think the new price represents an opportunity to invest at an even lower value, even better, right?

But how scalable does this strategy become when it drops another 20%? You now need an 100% rise in price just to break even, and the likelihood of which is minimal. The fact is, while averaging down can and does work, it is an unsustainable trading strategy, and simply not one you should get into the habit of employing. The key to success in CFD trading is learning to cut your losses early and this requires an unbiased, impartial and objective mindset.

Obtain the mindset to cut your losses early.

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Over trading takes two forms; frequency and open positions. With the news and major data releases now so popularly-accessible, the sheer quantity of market-influencing information to choose from is mind-bending. With information coming from newspapers, financial magazines, investor websites, platforms and brokers, it’s important to stick to your trading plan and not be taken in by impulse trading opportunities. It’s always worth remembering that trading opportunities are always going to arise, but it’s up to you to keep your account open long enough to see to it that you can take advantage of them, so keep the number of trades you make to a manageable number. It’s important to remember that the more positions you open, the higher the risk. In addition, more trades means more distraction, which can, in turn, mean holding more positions longer than originally intended in the hopes of profiting from an eventual turnaround, contrary to your original trading plan. The result of incorporating your limits and weaknesses into your trading plan will be a much more profitable and satisfying CFD trading experience, and more importantly, you’ll be minimising the risk in what is otherwise a high-risk market. Lastly, simply recognising that you’re over trading is half of the battle; everyone is guilty of over trading at some stage, but realising your mistake means you still have time to correct it. Similarly, over trading typically occurs when traders allow emotions to cloud their objective decision-making. Paradoxically, the fear of loss is often the cause for losses because it can make traders adopt an overtly defensive strategy. So, trust your rational judgement and stick to your plan to avoid making this common trading mistake.

OVERTRADING

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Don’t let yourself be taken in by impulse tradesOver-trading reduces the efficacy of your overall strategyRemember, there will always other opportunities to trade

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Some traders opt to use long-only positions when trading CFDs. This is a poorly-devised strategy because it not only means you won’t be able to benefit from downward turns, but it also increases the risk with which you are trading. Naturally, with a long-only trading strategy, the fate of your account is subject to the chances of a rise-only market and when the market falls, all your positions lose money.

This introduces unnecessary risk. With the use of a few short positions, you can hedge your portfolio and open up the option of pairs trading. This helps to increase your flexibility, with a more varied portfolio containing both long and short positions you ensure a more balanced group of investments. You should be aware however, that short positions carry their own risks, with the potential to theoretically go on rising forever, so make sure to use your own market analysis to inform your short positions. You can also use pairs trading to help safeguard your portfolio; pairs trading is a defensive strategy, and is practiced by buying, one market and selling its competitor. Let’s say, for example, you go long on Morrison’s on the grounds of a belief that their shares will rise. You may then decide to go short on, say, the Co-op, a Morrison’s competitor, on the grounds that their share prices will fall. This would be a defensive strategy, because you are hedging one position against a directly linked other.

Think about the option of pairs tradingPairs trading is a defensive strategy

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RESTRICTIVEPORTFOLIOS8

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If you’re reading this, you’ll likely have spent some time researching CFD trading, which in turn means that you’ll have come across plenty of traders claiming to make enough money to live out their millionaire lifestyle with only 15 minutes of trading time each day. Whilst some of these stories may well hold some truth, the reality for the vast majority of traders is much less glamourous. If your trading plan requires a return of, say £2,000 per month based on an investment of £10,000, then you’re likely to be disappointed by the outcome. Trading is about picking a realistic pace and sticking to it. Similarly, your trading plan needs to incorporate appropriate stop-loss and take-profit levels, relative to your own personal ability to withstand losses. The unfortunate truth of CFD trading is that the risks can often outweigh the rewards, so a trading plan that prioritises a slow-and-steady approach will ultimately be of more use to you than an account that occasionally offers a successful trade but turns a consistent loss the remaining time.

The risks of CFD trading can sometimes outweigh the benefits

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IMPRACTICALTRADING GOALS9

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This is a mistake that somewhat ties into every other point made in this e-book, and as such serves as a good point on which to conclude. CFDs are high risk, and a laissez-faire attitude will result in losses. As a result, you should only ever trade CFDs with that which you can afford to lose. Once you’ve determined your investment capacity, your trading plan should take into consideration how you will decide upon exposure, open positions, diversification and leverage. In addition, you need to minimise the risk you take by using risk management tools, including regular, guaranteed and trailing stop-losses.

Also bear in mind that running through your trading plan prior to entering into any trades will dramatically reduce the chances of losing sight of your long-term trading goals. Ultimately however, the biggest risk when CFD trading is not being absolutely honest with yourself; if you don’t have the necessary funds or your trading style tends to be risk-averse, CFD trading simply isn’t going to be an appropriate trading option for you. There’s a world of other trading opportunities out there, so if this is the case for you, don’t be disheartened; you will likely be saving yourself a good deal of money and stress.

CFD trading can be confusing and highly stressful, but if you take the necessary precautions to avoid these common mistakes in your trading plan, you can dramatically cut your exposure to risk on the CFD trading markets.

INCREASING RISK EQUALS QUICK PROFIT

Utilise risk-management tools to minimise risk

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