While viewed as an option by an ever-growing number of people, trading is a challenging task. To venture into the trading ecosystem, whether you’d like to get involved in technical, swing, intraday, derivative, leverage, or any other type of trading, you must carry out considerable research. Make sure you understand the intricacies of the trading world and be prepared to deal with a significant amount of risk. If you’re not comfortable with price fluctuations or volatility, it might be best to reconsider trading.
One of the first things you’ll learn in the trading world is that you won’t always be able to access the capital necessary for substantial returns. As such, you can get the opportunity for significant market exposure via the usage of leveraged products. In the UK, two options are particularly popular: contracts for difference and spread betting. They are fundamental for equity, index, and forex markets. And while their use cases are similar and share many of the same benefits, each has its unique advantages. But is there one that’s better than the other, or does it depend on the particularities of your trading profile?
CFDs
Contracts for difference, more commonly referred to as CFDs, are derivative contracts between financial institutions and individual investors. This contract allows you to take a position on the future of an asset for its value. This is similar to spread betting, which allows investors to place money on whether they believe market values will rise or fall. The differences between the opening and closing prices are cash-settled. While there’s no delivery of either physical goods or securities with CFDs, the value itself is transferable by force.
Don’t mistake CFDs for future contracts. While they permit traders to deal in the price movements of futures, the similarities stop there. Contracts for difference don’t have expiration dates or preset values, but they trade like other securities, based on buy and sell prices.
Spread Betting
Spread betting is a type of leverage that allows traders to speculate on the movements of several financial instruments, including fixed-income securities, forex, and stocks. Since the speculation is tax and commission-free, you can speculate during both bull and bear markets. You don’t have to worry. You’ll be hindered in your trading process depending on the strength of the current markets, which is excellent news considering 2022 has been a bearish year for investors. And since the market winter doesn’t show signs of letting up anytime soon, looking into your options is a necessity.
Spread betting works by enabling you to place a bet on whether you believe a market is set to expand or fall from the time your bet is accepted. You have the opportunity to choose how much risk you’re willing to take on this bet. And much like in the case of stock trades, you can mitigate risks by using stop loss or getting profit orders.
The similarities
When you’re a trader, you want to get the best solutions for your endeavours, so you’ll, of course, wish to add the best solutions to your strategy. So, what are some of the main similarities between the two? The first and most obvious one is that both are leveraged derivatives. Both have value deriving from an asset and are well-known alternatives to direct investments. As the trader, you have no ownership of these holdings, and you aim to speculate on future prices. Opting for a short selling position enables you to gain the difference between the opening and closing values if the asset decreases in value over time.
If you’d like to do more in-depth research on spread betting vs CFD, you can click here to read more. You can get a better idea about the taxes and accessibility associated with the methods and the potential issues you must be aware of before setting out to commence a speculative trade. Both spread betting and CFDs come with additional commission fees and overnight costs. The use of leveraging during trading gives you increased exposure to financial markets.
Advantages and disadvantages
So, what are the pros and cons of each method? In the case of CFD, you trade on the margin, which provides higher leverage compared to traditional trading methods. The lower the margin requirement, the greater the potential returns for your trades. Generally speaking, there are fewer regulations associated with CFD when compared to other exchanges. The initial capital requirements can be pretty low, and you can start an account with as little as $1,000.
In the case of spread betting, one of the main advantages is that you can speculate on falling markets. Depending on your requirements, you can choose between several order types, including:
- Market orders: The trade is executed immediately at the current market price.
- Limit orders: You can trigger the trade for a specific price, whether above or below current values depending on your choice.
- Stop-entry orders: This method allows you to catch the momentum and enter a trade at a selected price.
However, there are also some disadvantages associated with the trade. In the case of CFD, leverage can also magnify your losses. Price volatility and fluctuations can lead to substantial differences in spread trading ventures. The industry is not highly regulated, which can make you wary of giving it a try. It is also not allowed in some countries and jurisdictions.
The disadvantages of spread betting, hedging isn’t guaranteed, and any losses you may incur are not tax deductible. You can only trade in the currency of your account, so all your transactions are in one currency, which can seem to limit some traders. There’s also no direct market access in spread betting, and there’s no model for corporate accounts.
Ultimately, the choice is up to you. Before deciding which option works best for you, make sure you have done your research and understand all the potential risks associated with trading and its methods.
Disclaimer: Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.
Tax treatment depends on your circumstances. Tax law can change or may differ in a jurisdiction other than the UK.
Marketing for CFDs and spread betting is not intended for US citizens as prohibited under US regulation.
Contracts for difference (CFDs) are a form of derivative trading that can be used to earn money. It is important to understand the algorithms and rules of trading and trade using a CFD account.
When investing, there is an interaction between the seller and the buyer, the result of which is a purchase and sale transaction. This is similar in trading, although you don’t take ownership of the asset directly. Financial assets can include stocks, bonds, currencies and more.
CFDs are an agreement to exchange different prices for a specific asset between the time that you open the contract and close the contract. In this case, you can benefit from an increase or decrease in value, although you can also experience losses if the markets move against your favour.
How to manage capital risk
Market risk in CFD trading is a common occurrence. You can face serious difficulties and suffer losses. To avoid unnecessary risks, you could follow some simple guidelines:
- Deal with trusted intermediaries
- Study the market
- Have an analytical approach
- Buy several assets that belong to different industries to diversify your portfolio
News is an important aspect
Traders should stay aware of events in the financial markets that can influence price movements. As releases such as company reports are prepared in advance, trends can be discerned.
The mood of market participants can change quite quickly, and a CFD trader needs to be ready to take decisive action. The news trading strategy is well suited for determining price volatility in the short term. It can be used for the following:
- Gain on a predictable price difference
- Analyse available information from the general environment
- Open new positions based on news events and releases
- Take into account the factor of positive and negative impact on open positions
If you miss important information, you may lose time also. Some releases may have a significant impact on certain sectors of the economy, as well as on specific countries and regions.
If you’re considering entering into large positions before the release of major news, you do not know how the market will behave, so it may be better to wait in some instances. Keep an eye on company earnings reports, dividend information and other important news.
Hedging
Hedging is implemented in two ways. In the first case, you acquire opposite assets. If there is a crash in one market, you could benefit from stability in another market. In the second case, you buy and sell the same instrument, therefore insuring yourself against serious price fluctuations of the asset.
CFD hedging is characterized by the following features:
- The strategy becomes especially relevant if the level of price fluctuations is high
- This method is often used when there is a need to fix the profit
- The level of risk is reduced to a minimum
Suppose you’re trading CFDs on Netflix shares. They’re 2% more expensive, and that growth should continue. But you intend to protect that profit. In this case, you can close the position or resort to hedging.
You could enter into a contract for difference in the other direction, which will allow you to avoid problems when the share price declines. If you have such a position, you are less likely to suffer losses. However, this method should not be used in all situations and isn’t guaranteed to protect you.
Example
For a better understanding of the CFD trading process, let’s look at two examples of transactions. Suppose you buy Apple shares at $160 per share. After a week, their value increases to $180. If you decide to sell them, you will net a profit of $20.
Now consider another scenario where you purchase a CFD contract for shares in the same company. With the help of leverage, instead of $20, you could earn $100 or even more as the value increases (or lose that equal amount if unsuccessful), as leverage gives you greater exposure to the markets. It should be noted that it takes tens or hundreds of thousands of dollars to invest in a large share, so trading derivatives is a much easier option for many people.
Conclusion
The advantages offered by CFD trading need to be compared with the disadvantages if you’re making a decision on whether to trade. Of course, no one promises guaranteed success. CFDs can open up great opportunities if you properly analyze the market, choose a successful strategy, and show flexibility and consistency in your approach.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.
Marketing for CFDs and spread betting is not intended for US citizens as prohibited under US regulation.
So far, this year has been anything but typical. As nations have attempted to regain their footing after a difficult 19 months or so, inflation fears and spiralling energy prices have cast a very dark shadow on worldwide economic recoveries.
Even as world leaders prepare to convene for the UN Climate Change Conference of the Parties (COP26), global fossil fuel prices are soaring. While oil prices have hit multi-year highs in the US, with Brent crude sitting at $86 a barrel, the situation in Europe grows grim, as crude and gas have crept up to near all-time highs. As we approach the colder months, where demand for these commodities usually tends to rise in line with changing weather conditions, many traders and investors may be wondering if we are in for a particularly volatile winter. So, what factors should individuals consider when weighing up their investment activities?
‘Stagflation’ may cast a dark shadow
One aspect which may exacerbate usual seasonal patterns is the fact that we are currently in a ‘stagflationary’ environment – a deadly combination of rising prices, rising wages, low productivity, low growth, and rising unemployment. No doubt, this will be a pressing concern for investors given recent CPI data, as a prolonged period of inflation may drive central banks to raise their interest rates. What’s more, energy rationing and contracting consumer budgets may also spell trouble for the economy, stifling global growth. The result of all this? Energy prices may pose a road bump on the path to post-Covid recovery.
As such, I would advise traders and investors to watch central bank meetings closely. Not only will the minutes of monetary policy committee meetings give a direct insight into the thoughts of leading economists on these issues, but they will also provide a forecast of where inflation is headed.
At the moment, inflation figures have steadied somewhat in the UK, where the energy crisis originated, to 3.1% in annual terms for September. That said, the newly appointed chief economist at the Bank of England (BoE) Huw Pill has offered some words of caution, warning that inflation figures may top 5% by early next year – which could prove problematic for a central bank with an inflation target of 2%. Now, traders and investors are expecting a potential interest rate rise from the BoE at their next meeting on 4 November. Up until now, the Federal Reserve and the European Central bank are months behind taking such action.
Investors should also consider the fact that, generally speaking, oil tends to have a significant effect on currencies, as it has a strong inflationary component. In effect, this means that any volatility in oil prices will result in serious implications for the FX world. While central figures maintain that, like inflation, the energy crisis is “transitory”, I would still advise investors to keep their ears to the ground for any rumblings about oil.
COP26 will mark a shift to cleaner energy
Additionally, the upcoming COP26 summit on 31 October will contribute to something of a shift where usual seasonal patterns are concerned. Given that the recent energy crunch has marked a turn back to ‘dirtier’ sources of energy like thermal coal and oil, traders and investors can expect world leaders to recommit to old pledges to reduce their carbon emissions and accelerate these plans. While such efforts may seem like a given, the pace at which this transition occurs should provide traders and investors with some more nuance; so too will the inevitable opportunities that come along with an event like this. The summit will likely result in a new push for greener investments – clean energy sources, as well as the technology required to advance, transmit and store it, will provide new avenues to investors. Here, though, it is important to note that investing in any emerging market, and particularly energy, can come with some risks.
‘Tis the season
While most investors are no strangers to the fact that cold weather conditions tend to result in higher energy prices – particularly in the winter months – worsening weather conditions could exacerbate this trend. At the moment, meteorologists are predicting that the UK is in for a bitter winter, which could result in further gas shortages and supply bottlenecks.
In short, it seems like this year we can expect normal seasonal patterns to be amplified by the energy crisis, as well as other extraneous factors. While none of this is certain as yet, traders and investors should ensure that they anticipate any market shocks.
High Risk Investment Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. For more information, please refer to HYCM’s Risk Disclosure.
About the author: Giles Coghlan is Chief Currency Analyst, HYCM – an online provider of forex and Contracts for Difference (CFDs) trading services for both retail and institutional traders. HYCM is regulated by the internationally recognized financial regulator FCA. HYCM is backed by the Henyep Capital Markets Group established in 1977 with investments in property, financial services, charity, and education. The Group via its relevant subsidiaries have representations in Hong Kong, the United Kingdom, Dubai, and Cyprus.
The good news is that it's now easier than ever to join the ranks of the world's millions of active traders in a number of different ways.
For instance, you can hire a broker and purchase shares directly, use a trading app, buy CFDs (contracts for difference), join a DRIP (dividend reinvestment program), sign up with your employer's stock purchase plan, and get in on the action in other ways. Here's a short list of how people from all walks of life are getting involved in the securities markets. Note that you aren't limited to only one way because it's legal and common to use two or more methods at the same time.
Traditional Stocks
You can always take the traditional route and call a brokerage firm to place an order for shares of your favorite corporation's stock. This method has been around for more than 100 years, and people still use it. However, with all the speedy technology available today, and the ability to bypass traditional brokers, this way of getting involved in securities trading is not as popular as it once was.
CFDs: Contracts for Difference
If you prefer to use an online broker, as millions of people do every day, CFDs offer a fast, inexpensive way to take part in the action of the global securities exchanges, either as a buyer or a seller. CFDs are unique instruments that let you go long or short, with no commission, by purchasing a contract rather than directly buying shares. That contract is essentially a prediction that you make about whether the underlying stock will rise or fall in value. They're one of the simplest ways for new and experienced traders to get involved in today's fast-moving markets.
CFDs are unique instruments that let you go long or short, with no commission, by purchasing a contract rather than directly buying shares.
Trading Apps
Some investors prefer to do everything on their mobile devices, which is why some of the trading apps have become wildly popular. It's easy enough to follow multiple prices and securities, make instant buys, sell just as quickly, and do it all from your handheld device, tablet, laptop, or virtually any computer that's connected to the internet. Keep in mind that you can combine just about any of the popular apps with your own brokerage account. Most of the better online brokers offer site-based apps, programs, and platforms that can do just about any kind of analysis you need. Plus, you can use nearly all of them on your mobile device as long as you download the software from your brokerage site.
ETFs and Mutual Funds
Exchange-traded funds (ETFs) and mutual funds are two of the common ways for investing enthusiasts to gain exposure to a broad range of companies or sectors at the same time. They behave much the way index funds to but with a narrower focus. For example, you might select an ETF that tracks the entire healthcare industry and is made up of 20 or more stocks in that particular niche. When healthcare, as a whole, does well, so does your ETF. Mutual funds work pretty much the same way but tend to come with more fees and not offer as direct a connection to specific market segments.
DRIPS
Dividend reinvestment programs have been around a long time but are enjoying a new surge of popularity among first-time and experienced investors. When you join a DRIP, there's usually a small fee, but after that all your purchases are commission-free. When one of your holdings pays a dividend, the amount is automatically reinvested into the portfolio in the form of a fractional share. If your DRIP doesn't offer fractionals, then the money is simply held in your account until the amount is sufficient to buy another whole share. DRIPs are an effective way for account holders to magnify the power of their dividends by plowing the money directly back into the portfolio.
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Employer-Based Funds
If you're lucky enough to work for an exchange-listed company, it's possible to buy a set number of shares at reduced prices on a set time schedule. Many companies allow workers to purchase five shares, for example, every month for slightly less than market value. Most of these employer-designed programs forbid buyers from selling for a certain amount of time, like one year or six months.
The opening months of 2020 have presented a unique challenge for traders, with markets regularly making sharp and often unpredictable shifts in value. Disruption to international trade and geopolitical tensions dramatically influenced market sentiment during the first quarter of the calendar year, making it difficult to produce long-term market forecasts with any degree of confidence.
When volatility reigns, the need to minimise the risk of investments becomes greater than ever. This has prompted investors to consider the advantages of trading CFDs, and the benefits of subsequently hedging CFDs to reduce their market exposure if needed.
What Are CFDs?
CFD stands for 'contract for difference', with these contracts available for trade on stocks, shares, currencies, and commodities. Traders never assume ownership of the underlying asset, instead speculating on the increase or decrease of that asset throughout the duration of the contract. The difference in the asset's price between the start and end of the contract determines whether a trader is in profit.
Going long on a CFD position is when the trader anticipates the asset will rise in value. Conversely, going short is where the investor forecasts a decline in market price, sealing a profit if the asset does shed value during the contract period. A short position is sensible when markets are reeling from major world events, while going long is suited to more prosperous times for industries.
Why CFDs Are Suited to Difficult Conditions
Buying shares, purchasing a currency, or investing in a commodity is usually done in the hope that the asset will increase in value. During times when there is limited upward mobility for markets, traditional investment routes lose their appeal. CFDs are ideal for difficult times, as an investor can speculate on a rise or, crucially, a fall in the value of an asset.
Tough market conditions may restrict investment capital, but leverage in CFD trading ensures that a comparatively small proportion of capital is required to open up a large position on a market. While the CFD trader is liable for any losses accrued by the CFD, leverage allows investors to establish substantial positions that may otherwise be unattainable.
CFDs are ideal for difficult times, as an investor can speculate on a rise or, crucially, a fall in the value of an asset.
Further expenditure is saved through stamp duty; CFD traders aren't required to pay this tax, as they never have ownership of the asset. CFD investors can make their money go further during difficult trading conditions, but it is the ability to hedge CFDs that reduces the risk of being compromised by dramatic market shifts.
How Hedging CFDs Works
An investor has the option to hedge their CFD trade by opening the opposing position on an asset. For example, the trader may have a long position on an asset that is declining in value. By shorting that same asset, a trader can then earn money from that price decline and compensate for some of the losses from going long.
That asset may prove resurgent and end up with an overall rise in value once the contract ends, with the hedged position diminishing a trader's profits in this situation. While a hedge reduces the profit that can be made from a trade, it reduces the amount of capital that can be lost.
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This is why hedging CFDs is attractive during times of market volatility. A trader can research their CFD down to the minutest detail, but unforeseeable developments can turn a good position into a bad one. Hedging mitigates a trader's losses on a failing CFD, delivering a degree of compensation when the market moves in an unfavourable direction.
CFDs can be purchased on major financial markets, use leverage to reduce investors' initial outlay, and enable traders to speculate on movements in either direction. These factors make CFDs suitable as a trading strategy during difficult conditions, while the potential to hedge minimises traders' exposure to market volatility.
This begs the question – is there a formula that traders rely upon to effectively manage their investment portfolios?
According to Giles Coghlan, Chief Currency Analyst at HYCM, in short, the answer is no. Below he explains why the size and complexity of financial markets means it is virtually impossible to stay on top of every major and minor trade occurring across the world’s key markets.
Investors can consult with online tools that provide live updates and succinct summaries of asset price movements; however, having access to this knowledge will only go so far. The big challenge is understanding how to use this information to inform trades and investment strategies.
With the US-China trade war, the US Presidential election, the spread of the coronavirus, and the UK’s withdrawal from the EU just a few of the major events likely to shape 2020, now is an important time to understand the techniques regularly used by traders and investors when confronted by certain political and economic conditions.
The stock market is all about cause and effect
Staying on top of market movements can best be achieved by first understanding the basic principle of causality. By this, I mean that one event, trend or market movement will inevitably contribute to another, leading to a constant hive of activity.
For example, decades’ worth of quantitative evidence indicates that during volatile trading periods (often brought on by an unforeseen political or economic event), investors rally to hard assets like gold and oil. This model was played out in the opening weeks of 2020. With military tensions between the US and Iran rising, market demand for gold surged considerably. As a result, its price per ounce reached $1,600 USD on 7th January 2020 – its highest price in nearly seven years.
In the above scenario, investors rallied to gold due to its ability to retain or increase its value in times of market turbulence. This is why it dubbed a ‘safe haven asset’. What’s more, a similar observation can be made when confronted with the opposite scenario.
History regularly demonstrates that during periods of market stability, investors tend to look to stocks and shares. While much more sensitive to sudden movements and shifts, these soft assets also allow investors to leverage growth in different sectors by actively investing in different companies. Investing in stocks and shares can also bring with it the added benefit of dividend and stock repayments.
History regularly demonstrates that during periods of market stability, investors tend to look to stocks and shares. While much more sensitive to sudden movements and shifts, these soft assets also allow investors to leverage growth in different sectors by actively investing in different companies.
Understand what type of investor you are
For early-stage investors, there is a tendency to think that acting fast when reacting to a sudden market movement can deliver significantly higher returns. While this is true to an extent, it also fails to consider the huge level of risk involved with such a tactic. Professional traders and seasoned investors understand this, which is why they are prepared to take on any losses that could be incurred as a result.
Alternatively, for those using the financial markets as a way of building up solid, long-term returns, engaging in short-term trades is a very high-risk strategy that could incur significant loses. Not accounting for these loses might then result in an investor having to restructure his or her investment portfolio and ultimately change their financial strategy.
There is no right or wrong answer here. High risk, high return investors approach the markets in a completely different manner than low risk, low return investors. Regardless, it is important to identify what type of strategy you’re adhering to and stick with it.
For example, renowned investor Warren Buffet stayed committed to his value-orientated strategy during the 1990s by deciding not to invest in the dot-com boom. In the short-term, he did lose out on immediate gains from tech companies that were increasing in value and size. Yet in the long-term, he also avoided the dot-com crash, where many of the online companies that initially emerged began to crumble.
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The same can be said when faced with a sudden market shock. The key rule to remember here is not to panic but rather trust the financial strategy you have in place. Acting with your heart instead of your mind is never a good idea in the world of investing.
Use the market to your advantage
There is ultimately no perfect formula or strategy that is universally applicable to all investors. However, by learning about past events and understanding how different asset prices reacted, there are plenty of underlying lessons that can be taken onboard.
Above all else, creating and adhering to an investment strategy that aligns closely to your financial goals cannot be overlooked. And if you are ever in doubt, be sure to speak with a financial professional.
High Risk Investment Warning: CFDs are complex instruments and come with a high risk of losing money
rapidly due to leverage. 67% of retail investor accounts lose money when trading CFDs with this provider.
You should consider whether you understand how CFDs work and whether you can afford to take the high risk
of losing your money. For more information please refer to HYCM’s Risk Disclosure.
Studies show that a large portion of forex traders fail. The problem is that most do not prepare adequately before starting their live trading activity.
You can increase your chances of becoming a successful trader by identifying the mistakes that most traders do and avoiding them. The following are some of the common mistakes that beginner forex traders do and our tips on how to avoid them.
Mistake 1: Not enough forex education
You will never trade successfully unless you invest in education. Many beginners start trading with a gambling mindset. However, successful forex trading requires an understanding of the global markets, trading strategies and technical and fundamental analysis. You need to know how to use financial information resources like Bloomberg or the Financial Times, charts and other tools.
Once you are confident with your knowledge you should test it with the help of the demo account. Demo trading is the best time to test different strategies. You should not start live trading until you identify a trading strategy that you feel comfortable with in the demo environment.
Mistake 2: No risk management plan
Forex trading is a high-risk venture, and it is therefore critical to have a risk management plan that factors in the amount of risk you are willing to take. Once you identify your risk appetite, you should identify trading tools to protect yourself against additional risk.
For example, you can implement a stop-loss to close trades when the prices hit your risk threshold. Likewise, you can have a 'take-profit' feature in place to lock in trades when your target price is reached. These are not the only risk management practices you can adopt and before you start trading you need to be aware of all important practices and how to use them to your advantage.
Mistake 3: not sticking to your risk management plan
You can have a trading strategy and a risk management plan, but you will achieve nothing unless you follow them. Remember that forex trading requires high discipline. Traders often ignore their risk plan when chasing losses or when they feel overconfident about a specific trade. You should learn to identify the urge to ignore your risk management plan as an emotional reaction and keep reminding yourself that emotions are the number one cause of wrong decision making in trading.
Mistake 4: Choosing the wrong broker
Most novice traders assume that all brokers are equal. This is not true. There are many factors that can differentiate one broker from the other and choosing the right broker has a huge impact on your success or failure in the trading world.
But if we can think of one factor that is simply crucial to check before choosing a broker it is the license. You should only work with forex brokers like Capex.com who have a license from top regulatory bodies. If a broker is not regulated by one of these bodies then it cannot be trusted and you should not work with them.
Bottom line
It is always good to learn from other people's mistakes and this is what we have tried to help you do in this article. We do hope that you learned the pits and falls of forex trading and that you will have the patience and discipline to avoid them.
Trading forex, especially with CFDs may involve a high risk and your potential losses when trading CFDs may be substantial.
