Using CFDs to Trade Volatile Share Markets
We are currently experiencing a once in a lifetime economic event.
With an unprecedented amount of uncertainty in every aspect of our livelihood, the share markets are in turmoil. How do you stay ahead of the game?
What Opportunities Do Volatile Markets Present?
For long-term ‘buy and hold’ players, volatility is a cue to stay away. For short-term traders, the volatility that we are seeing on a daily basis opens up a gold mine of potential. And with this potential, comes a lot more risk.
Check out the recent daily movements in the S&P 500 (the 500 largest companies listed in the U.S.)
March 2020 – 17 Day S&P 500 volatility
For some context, there have been 16 days in the last month that the S&P 500 has swung by 3%+
In the five years prior to last month, there were 11 days in total that had swings that large.
With such large movements in prices on such a regular basis, short-term trading in the current market volatility is presenting a once in a lifetime opportunity.
What Is CFD Trading?
CFD trading is facilitated by online brokers and is most commonly centred around Shares, Foreign Currency, Indices, Commodities and ETFs.
A CFD (or a ‘Contract For Difference’) is a form of derivative trading in which you never own an underlying asset – i.e. you will never own the physical share, commodity or currency.
The mechanics of how a CFD works can get confusing – so if you want the finer details, you can get a full rundown here.
The critical thing to know about CFD trading is that there is potential for much higher, accelerated, short term returns – and with that comes much higher risk to your capital.
Why Is CFD Trading so Risky?
Margin & Leverage.
When you trade CFDs, it is possible to trade with leverage. This means that your exposure can be greater than the capital you have in your account.
Let’s talk about a hypothetical trade of an Apple Inc (AAPL) CFD using a hypothetical 10:1 leverage.
To open a $4,000 position in this Apple Inc CFD trade, your margin would be $400 (and your leverage would be 10:1).
To open a $3,000 position in the same Apple CFD (with 10:1 leverage), your margin would be $300.
Ok. I get it. My leverage is 10:1 which means that for a $4,000 position I need $400 margin. But what does that actually mean?
If you open a $4,000 position in an Apple CFD at 10:1 leverage, it means that your profit and loss will be calculated as if you owned $4,000 of Apple Inc shares.
Of course, you don’t own $4,000 of Apple Inc shares (because you are trading CFDs) but you already know that, so we’ll keep going.
Now, if you are holding the position above and the Apple Inc (AAPL) share price increases by 5%, you will be looking at a $200 profit from your trade (being 5% of your $4,000 position).
That’s right, you only used $400 in capital to open the position yet you are profiting $200 from a 5% swing in the share price.
That is the power of leverage.
However, if you are holding the same position above and the AAPL share price drops by 11%, you will be -$440 from your trade (being 11% of your $4,000 position).
If you only had $400 in your account then this means your trade will automatically be closed and your balance will be $0.
If you had more than $400 in your account, your position will become negative and you will start risking the rest of the capital in your account.
And now you can see why CFD trading is so risky.
Do I ‘Short’ (sell) or Do I go ‘Long’ (buy)?
Essentially this is to “sell” or “buy”.
To ‘sell’ or to ‘short’ is to enter a position in which you will profit if the price of the instrument goes down.
If the price of the instrument increases, you will make a loss on your position.
To ‘buy’ or to ‘long’ is to enter a position in which you will profit if the price of the instrument goes up.
If the price of the instrument decreases, you will make a loss on your position.
A lot of people have a natural bias towards going ‘long’ or entering a ‘buy’ position when it comes to trading.
The beautiful thing about trading CFDs is that they have no emotion, there is no bias or preference to a movement in either direction.
To succeed in short-term trading, you must be willing to trade in both directions.
Where to Trade CFDs?
Our preferred trading platform for CFDs is Plus500.
Plus500AU Pty Ltd (ACN 153301681) is licensed by:
– ASIC in Australia, AFSL #417727,
– FMA in New Zealand, FSP #486026;
– Authorised Financial Services Provider in South Africa, FSP #47546.
You do not own or have any rights to the underlying assets. Please refer to the Disclosure documents available on the website.
Here are our pros and cons of using Plus500:
Highly Trusted ✅ Fees higher than some
other brokers ❌
2,000+ Trading Instruments ✅ Large spreads on
some instruments ❌
Efficient Deposit and Withdrawal ✅
User-Friendly Platform ✅
Great Web and Mobile Options ✅
We recommend starting with a Demo account to familiarise yourself with the platform and the trading concepts.
Click Here to Set Up Plus500 Demo Account
It is important to note that between 74-89% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.