CFDs offer the ability to trade both long or short and it is a great idea to take advantage of this opportunity. It’s another tool added to the tool box, because trying to trade shares when the market is in a heavy down trend is a recipe for disaster. If the only tool you have in your tool box is a hammer all problems start to look like nails. CFDs allow a much more flexible approach to market conditions.
Trade in the Direction of the Trend
Trade in the direction of the trend is a rule that is widely touted in the stock market, but what happens when that trend is down? Share traders are forced to sit on the sidelines until things improve, but CFDs come into their own. A simple measure like a moving average can be used to determine the underlying security’s direction. And trades can then be taken on the appropriate side of the market.
You can use the power of CFDs to align yourself with the market direction at any time. While it is possible to trade against the trend, it is much easier trading with it. Unlike in shares, with CFDs there will always be an opportunity to trade somewhere.
Looking at the chart you can see that while FLT was in a down trend there were certainly short term trading opportunities as it bounced higher, but the bigger moves occurred in the direction of the trend. CFDs allow you to align your trading with the market when it is falling and profit from these moves.
Net Long or Net Short
Another point to take into consideration with CFDs is your total net long or net short position at any time. As the market trends strongly in one direction it is very easy to build a large number of trades with the trend. Your account then becomes very susceptible to a sharp market reversal. If you are holding ten positions long and your risk on each trade is set at 10% of the $10,000 face value, a sharp reversal can wipe out 10 x 10% which is 100% of the $10,000.
So to minimise the impact of a reversal there are two options. You can place a limit on the number of positions that are held at any time or you can open both long and short positions simultaneously. The long positions are held in the strongest sectors or shares while the short positions are held in the weakest sectors or shares. The stronger shares should rise faster than the weaker shares if the market continues to rise and vice versa when the market falls. In the event a sharp reversal occurs then your long positions will still drop in value, while the short positions will gain making the impact less. Consider a mixed portfolio of both long and short positions to minimise your risk.
For those not trading shares, but looking at other markets there are relationships between US market indices and Australian indices, bonds and shares, US dollar and oil and US dollar and gold to name a few. By entering positions long and short in similar markets or diversifying into markets that are not related to each other you can minimise the impact of a sharp reversal on your whole portfolio.
By Jeff Cartridge
Education Manager
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The information provided within this blog is general advice only and you should consult the services of a financial professional in order to ascertain whether the information is applicable to your investment strategies and risk profile.
