Module 2: Best Practices When Trading CFDs 

2.1 Understand Your Investment or Trading Objectives

When trading contracts for difference (CFDs), it’s important to have a clear understanding of your objectives. This will help set the context for your decisions and allow you to maintain a disciplined approach. 

Here are three essential factors to consider, especially when you’re just starting out. 

1. Are You Trading or Investing? 

To the casual onlooker, trading and investing may appear similar; they certainly share the same activities and actions, such as keeping track of market news, placing and monitoring trades, and constructing and maintaining a portfolio. 

However, trading and investing are two very different approaches as seen in the following table:

Trading	Investing
Focus on short-term gains from market fluctuations	Purchase undervalued assets for long-term capital gain
Positions held for short to medium term	Positions held for the long term
Higher risk due to shorter timeframes and reliance on market volatility	Ignores short-term volatility but can risk losses during recessions
Strategies include day trading, scalping, and swing trading	Strategies include buy-and-hold, dollar-cost averaging (DCA), portfolio diversification, and hedging
Heavier reliance on technical analysis and charting tools	Technical analysis not required but fundamental analysis is important
Can potentially profit in both bull and bear markets	Only profits when exiting the market at a higher price than entry

To sum up, trading focuses on market volatility, using short-term strategies to capitalise on price action. In contrast, investing revolves around long-term capital appreciation, ignoring market volatility in the near term. 

So, where do CFDs fall in between these two categories? 

Well, the features of CFDs make it seem like only traders would use them—but that is not necessarily true. 

For example, an investor would be interested in protecting their portfolio during a market downturn. They can trade CFDs to short the markets, thereby hedging their portfolio against risk. 

Ultimately, CFDs can be used for both trading and investing purposes, as long as you understand how they work. Having CFDs as part of your toolkit can help expand your options, whether as a trader or an investor.

2. Risk Appetite 

When trading CFDs, it’s important to set realistic expectations. You should make it a point to trade only what you can afford to lose.  

This means matching your risk appetite to your trading budget. For instance, if you only have a trading budget of $1,000 each month, you should ensure your capital at risk never exceeds this amount. This is especially so as CFDs are leveraged products—should the market move sharply against your position, you can rack up large losses very quickly.  

Taking on a larger trade than your budget allows is unwise, and could backfire on you should your trade go wrong. However, if you ensure your risk appetite matches your budget, you can likely continue trading next month without jeopardising your financial status.  

3. Managing Your Trading Account 

Realise that when you are granted a trading account by your broker, you are solely responsible for what happens to it—good or bad. You should protect your account from unauthorised use, safeguarding your ID and password from others. Never lend your account to anyone else, not even your closest friends or family members.  

Bear in mind that the account holder is legally liable for any losses incurred by the trading account. This means you will be responsible for monitoring and managing your trading account at all times, with no exceptions. 

2.2 Checklist for Opening a Trade: 5 Questions to Ask Yourself

Wondering what to look out for when opening a trade? Use this checklist to guide you along.

1. What Type of Trade Do You Want to Execute?

The first thing to decide is what type of trade you want to make.  

Do you think the market will go up? Or will it go down? Are you okay with entering the position at the current price? Or would you rather wait for a better price?  
 
Just as important, you should also decide when you will exit your position. What is your profit target? Or how much loss will you tolerate? 

All of these questions will decide the type of trade you need to make: 

• Think the market will go up? Open a long position. 
• Think the market will go down? Open a short position. 
• What’s your profit target and maximum acceptable loss? Set stop orders accordingly, placing take-profit and stop-loss orders at appropriate price levels.

2. How Large Should Your Position Be? 

Position sizing is the cornerstone of risk management. In essence, it simply means limiting your capital at risk to an appropriate amount when deciding how much to put into your trade.  

As a general rule, each position size should be 1% to 5% of your total trading budget. This decreases the likelihood of your account being wiped out should you encounter a string of bad trades.  

Take due care when deciding your position size—you need to account for the leverage used in your trade. Here’s an example to illustrate how leverage works.  

Let’s assume you have a total trading budget of \$10,000. You decide to set your position size at 5% or \$500; this is the maximum capital at risk (CaR). 

Your broker offers leverage up to 20x. This means with \$500, you can control a position worth 20 x \$500 = \$10,000.  

Assuming you go for the full 20x leverage, let’s see what could happen to your position:  

• Your position goes up 3%, now worth \$10,300 
  • You make a profit of \$10,300 – \$10,000 = \$300  
  • This a 60% return on your \$500 initial capital 
  • Your initial capital increases to \$800 

• Your position goes down 4%, now worth \$9,600  
  • You make a loss of \$10,000 – \$9,600 = \$400  
  • This is an 80% loss on your \$500 initial capital  
  • Your initial capital is reduced to \$100 

What happens if your position loses 5% or more? Your initial capital would be wiped out, putting your trading account in the negative.  

However, if you chose a lower leverage of 10x instead, the full value of your trade would only be $5,000. This will reduce the magnitude of your profits, but choosing lower leverage will also make your trade more resilient to losses.

The takeaway: When using leverage, remember that even though you only put up a fraction of the total value of your position to trade, your outcome (profit or loss) will be calculated on the full position.

3. How Long Should You Keep Your Trade Open?

Inexperienced traders may be tempted to delay closing a winning trade, only for the market to turn on them, wiping out gains, or worse—turning your trade into a loss. The use of leverage accelerates the speed at which this could happen. 

Now, if you had set your take-profit order as mentioned earlier, your position will be automatically closed once the price hits your profit target. Yes, your total profit would be capped at the take-profit level you chose, but you’ll avoid the painful experience of seeing your win turn into a loss.  

The same goes for if your position goes against you. Due to sunk-cost fallacy, which is a well-known mental block among traders, you may be tempted to keep your position open in the hope of a turnaround that may never come.  

That’s why setting an appropriate stop-loss order can help prevent this from happening. 

4. Are You Managing Margin Calls Properly?

There’s another good reason to close your position in a timely manner—margin calls.  

In trading, margin is the deposit required to open a leveraged position. This means that if you trade with 10x leverage, your margin is equal to 10%.

Going back to the earlier example, let’s say you put down \$500 as margin to control a \$5,000 position.  

If the price moves against you by 20%, the position is now worth \$4,000—which outstrips your initial deposit by \$500 (or 100%). At this point, a margin call is likely to be triggered, where you are required to top up your account with additional funds. 

Margin calls need to be treated seriously, as failing to meet them will cause your position to be closed immediately. Any losses—likely to be significant by this point—will be allocated to your account, leaving you financially liable.

5. Are You Keeping Up With the Market News?

When setting up your trade, pay attention to market news that could impact your underlying asset or market. Some examples include company earnings reports and dividend payouts—this is when stock prices could undergo heightened volatility, affecting your trade.  

Unexpected news, such as corporate scandals or policy changes, could also spark off outsized price movements. By staying updated with timely market news, you can make a more informed decision about how to manage your positions.

2.3 Three CFD Trading Strategies to Get You Started 

1. Day Trading

Day trading is a trading approach that focuses on making multiple trades during the trading day. In day trading, traders do not leave positions open overnight to avoid holding fees, as well as the risk of markets gapping due to unexpected or unforeseen events.  

A day trader may trade any number of markets or assets, depending on their goals and preferences. Positions are typically short-lasting, ranging from minutes to hours. Any positions still open are closed by the end of the trading day.  

Being a day trader requires discipline, risk management skills, and realistic expectations towards results. It’s more important to maintain a favourable risk-to-reward ratio than to go for a high win-loss ratio.

2. Swing Trading

When observing a price chart, you may notice certain markets moving from highs to lows in somewhat regular patterns. Such markets are potentially suitable for swing trading, which is a trading strategy that attempts to capture portions of larger price movements for profit-taking.   

Upon identifying a clear price trend, a trader enters a swing trade, going long for uptrends, and short for downtrends. The trade is maintained until a profit level is reached or when signs of a price reversal is spotted. 

It’s not necessary to enter trades at the exact tops (i.e., swing highs) or bottoms (i.e., swing lows). The goal is to capture price movement as markets trend upwards or downwards.

3. Short Selling (To Hedge Against Risk) 

Short selling is an advanced trading strategy in which a trader borrows shares from a broker, sells them, and later buys them back from the market if the price drops. The shares are then returned to the broker, and the trader pockets the difference in prices as potential profit.  

In essence, short selling allows CFD traders to benefit in falling markets. When used appropriately, it can also serve as a hedge by offsetting losses from long positions within a portfolio.  

Note that short selling only works if the price of the underlying asset declines. Before entering a short position, it’s important to confirm your assumptions using technical indicators and tools.

Quiz

Module Recap

When trading CFDs, it’s important to understand your goals and objectives. 

• Know the Difference Between Trading and Investing: Trading attempts to profit from short-term price action while investing focuses on long-term capital appreciation. Both serve different goals and use different strategies.  
• Set Realistic Targets: Always align your risk appetite with your trading budget to help manage exposure without putting your overall finances at risk. 
• Manage Your Trades With Care: You are fully responsible for your trading account and should never share access with anyone else.

Preparing a checklist before opening a trade can help you avoid mistakes. Pay attention to: 

• Type of Trade: Will you go long or short? What stop orders will you use? And at what price levels? 
• Position Size: Limit each trade to around 1%–5% of your total trading budget. Remember that leverage amplifies both gains and losses, so choose levels carefully.
• Trade Duration: Use stop orders at appropriate levels to avoid holding positions longer than you should.  
• Margin Calls: Ensure you have sufficient funds available to meet margin requirements promptly. 
• Market News: Pay attention to announcements or events that may increase volatility in your chosen market or asset.  

Three common CFD trading strategies include: 

• Day Trading: A short-term trading approach that’s focused on intraday price movements, avoiding overnight positions. 
• Swing Trading: A medium-term trading approach aimed at capturing price swings during uptrends or downtrends.
• Short Selling: A strategy that allows traders to potentially benefit when the markets are falling. It can also be used as a hedge to offset losses in long positions.