This post was originally published by Deriv on 17 March, 2022.
CFD (contract for difference) trading allows you to speculate on the price movement of different assets without buying them.
The trade type’s high-risk, high-reward nature is the driving factor behind its increasing popularity. However, beginners may feel a little lost at first. That’s why it’s essential to establish a solid foundation before getting into CFD trading. Here are some tips and best practices to help you get started.
Dos: the best practices of CFD trading
Choose a reliable broker and the right CFD trading platform
It is absolutely necessary to check the credibility of any institution involved in your financial activities, especially the CFD broker you choose. You must ensure the broker providing the CFD trading services is regulated, and their licences are legitimate and updated. It’s also a good idea to check the reviews of other traders before selecting the platform most suitable for your trading needs.
Here at Deriv, we aim to provide the best trading experience for you. That’s why we keep all our regulatory information readily accessible. We also offer two options for CFD trading: the all-in-one Deriv MT5 platform and the fully customisable Deriv X platform. On these platforms, you can trade between CFDs on forex, stocks & indices, commodities, cryptocurrencies, ETFs, or synthetic indices under our derived indices.
Do your homework
As there are many trading terms to learn for beginners, researching commonly used jargon and concepts before you place your first trade is crucial. Once you feel comfortable, you can create a Deriv demo account to test your learning. Your Deriv demo account comes with an opening balance of 10,000 USD in virtual funds, allowing you to practise your CFD trading strategies risk-free.
However, learning doesn’t end there. With the trading industry constantly changing, you may occasionally encounter unfamiliar terms or concepts. To stay updated, check the latest posts by your broker or seek advice from online trading communities. After all, even experts need to refresh their knowledge periodically.
Diversify your portfolio but keep it balanced
With so many assets across various financial markets to trade on, CFD trading for beginners can quickly become overwhelming. Don’t spread yourself thin trying to learn about all the markets and assets at once, but don’t focus all your attention on one particular asset or market either. Find a balance that works for you.
As a starting point, it’s better to focus on 2-3 assets and markets. For example, if you decide to trade CFDs on stocks, choose stocks that belong to different industries, and try trading CFDs on stock indices too. It will give you a chance to study the markets in-depth and understand how prices react to various triggers.
Diversifying your portfolio across industries may also help to prevent you from losing more than you are comfortable with if an asset in one industry doesn’t perform well.
Use risk-management tools
There are a few risk-management tools you can use while trading CFDs. One useful tool is the stop loss feature. With stop loss in CFD trading, you’ll set the price at which you want your trade to close in case the market moves against you. When the market price touches or passes this level, your trade is automatically closed. If used effectively, setting a stop loss on your trades can give you significant protection.
Don’ts: things to avoid when you trade CFDs
Don't over-leverage your account
Most traders prefer to trade CFDs on margin, also referred to as leveraged trading. Trading on leverage means that you only need to pay a certain percentage of the asset value to open a trade while your broker covers the rest. Leverage allows you to enter the market with larger positions but smaller initial capital. Leverage may vary depending on the market you trade on, your country’s regulations, the broker you choose, and several other factors.
Using leverage is a great way to open larger trades, which can lead to larger potential profits too. While it can increase profits, it can also amplify losses. The rule of thumb here is that you are safe as long as you can pay the total amount of your trade, not just the percentage. If you can’t afford that, chances are you set your leverage number too high.
Don't fall prey to emotions when trading
When faced with potential loss, many traders start making impulsive decisions to win their money back, which usually leads to even bigger losses. Stick to a trading strategy and understand the reason for your loss rather than emotionally placing a trade to recover your money.
Another example of emotional trading is when people develop an emotional attachment to certain assets. But no matter how you feel about their future price movements, don’t change your plan. Stick to your initial strategy.
Don’t forget about the overnight fee
It’s a common practice among CFD brokers to charge an overnight fee on open positions. You should always consider if it’s worth keeping your trades open overnight, as it can go either way.
Scenario one — you have an unprofitable trade and hope to recover and turn it into a profitable one the next day. If the market goes against your prediction, you’ll have an even bigger loss and an extra fee for keeping your position open overnight. The same applies to trades with a very small profit. The overnight fee may wipe the profit out. So it’s always better to review and consider the trades you are unsure about.
On the other hand, sometimes keeping a trade open overnight can bring you a higher profit. However, you need to define a time frame within which you expect to see a profit on that particular trade. If it’s not profitable by a certain time, review it and decide if it’s worth keeping.
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There are many more lessons to learn to become a successful CFD trader, but knowing some of the essential dos and don’ts is the first and foremost step. If you’d like to learn more about trading CFDs and calculating profits/losses, check out our CFD trading guide.
Disclaimer:
Deriv X is not available for clients residing in the EU.
