New financial trading products have traditionally seen a very low rate of success. However, occasionally, a new product comes along and fires the imagination of investors and becomes a huge success. CFD (Contracts for Difference) is one such product that has captivated investor interest and spread across the global financial markets.
CFDs originated in the late 1980s in response to demands from institutional traders and hedge funds to short stocks without having to undergo the process of buying and owning the stock first.
Until the 1990s, institutional investors were the sole beneficiaries of CFDs. But as retail stock traders gained the opportunity to trade CFDs on the LSE, the attractive attributes of CFD trading become clear and a number of European and UK institutions joined the CFD marketplace. CFDs went on to gain immense traction following the global financial crisis of 2008 when investors all over the world started endorsing a product that allowed them to do away with the risk of owning the shares.
Understand how CFDs work and setting your goals
CFDs allow investors to benefit from the change in the value of an asset without having to own the underlying asset, which has led to a dramatic rise in their popularity. Yet another attraction is that, with CFDs, you can trade across asset classes — forex, commodities, and options, expanding the window of opportunity. This allows you to have greater diversity in your investments.
The overarching goal in CFD trading is to make money by setting positions. A well-structured trading plan is a self-regulating mechanism that allows you to define the risk threshold and operate within those parameters to your advantage. With the appropriate research and plan, it is possible to make the most of the stock movements and trends.
How a trading strategy will help
Building a trading plan takes time and patience. To start with, you should acknowledge and understand what type of market participant you are so that you can establish the parameters within which you will operate. CFD traders should understand the prevailing market conditions and prepare a plan based on those conditions and incorporate enough flexibility in the plan should market conditions change abruptly. The trading plan should have a clear overall trading objective, preliminary preparation, and well-defined trading methods and risk parameters.
Based on the plan, you will build a portfolio of stocks or other asset classes that fit into the framework of your objectives. The time you have spent on understanding the market, the specific stocks and the factors that could act as negative or positive triggers for those stocks ensure that you are well prepared for those events, limiting anything that has the potential to hit you as a shock.
Further, you will also study the performance of stocks in your portfolio vis-à-vis its peers so that you know when you have to switch a stock. In summary, a well-defined trading plan has all the attributes that will mitigate risks and make your portfolio robust.
