Contracts for difference (CFDs) are a very popular form of investing. Due to their rather straightforward nature when compared to other vehicles such as shares, many investors are keen to become involved during 2017. However, these instruments are not without their fair share of risk and countless individuals will suffer losses as the result of an incorrect approach. The most effective way to realise a profit is appreciating the pitfalls to avoid well in advance. It is for this reason that we will briefly examine a handful of common risks and how they can be mitigated.
Some analysts are already associating 2017 with a volatile marketplace. When we consider that even bonds may be affected, it becomes clear why CFDs might prove to be popular due to the myth that less risk is involved. However, the primary mistake that is made arises from an inability to cut losses during a losing streak. The concept of “letting it ride” nearly always results in a negative portfolio. Once a loss exceeds more than ten per cent of the initial position, it is best to liquidate the holding.
Failing to Capitalise on Profits
Although this may seem a bit odd, a milieu of investors will cut their winnings short in an effort to realise a profit. This can be extremely counterproductive, as CFD profits tend to accrue in small percentages as opposed to massive windfalls. We need to address psychology in this instance. The fear of a profit devolving into a loss can cause some to sell too quickly. Although there is no certainty in terms of when a bullish run may end, it is important to employ fundamentals as well as technicals in order to enjoy such momentum until it is time to sell.
The Question of Exposure
Another concept that can be overlooked in regards to CFD trading is the idea of exposure. A winning position could quickly cause an investor to allocate more funds into a specific trade. This is a very dangerous policy, for losses have been known to outstrip any gains that may have been previously made. Most professional fund managers will never place more than three or four per cent of their total holdings into a single CFD trade; irrespective to how lucrative it may initially appear. It is much better to diversify such holdings in order to counteract the possibility of a specific position “falling into the red”.
Fundamentals and Technicals
Many CFD traders (particularly novices) have a tendency of favouring either a technical or a fundamental philosophy. In truth, one cannot exist without the other. It is much better to take a more well-rounded approach in order to maximise the possibilities of walking away a winner. This can be difficult for some, as technical analyses are known to be quite complicated on occasion. However, appreciating how each can impact the other is critical to determine when a trade should be placed and when is the best time to liquidate a position. If you feel that one approach tends to dominate the other, it may be wise to take a step back and absorb the useful information presented in portals such as CMC Markets. Knowledge is indeed power.
Failing to Diversify
Many CFD traders will remain within what can only be called a “comfort zone”. In other words, they choose to execute those positions which are the most familiar. This is often the case when the markets turn more volatile. Certain analysts are predicting this exact scenario in the coming year. We need to appreciate that any lucrative CFD portfolio is associated with diversification into various sectors. Common examples include commodities, short-term Forex trades, blue-chip stocks and indices. A well-balanced portfolio is the best way to counteract any volatility seen within a single holding.
We have just highlighted some of the main pitfalls suffered by CFD traders of all ages. The most effective way to avoid such situations is to know the warning signs from the very beginning. Please feel free to use this article as a guide to shape your trading strategies throughout the coming year.