Skills vs. Strategy in CFD Trading

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Skills vs. Strategy in CFD Trading

Even though most of the educational material out there is focused on trading strategies, in reality, skills are the ones generating results while trading CFDs. This could seem confusing for some of you, but there’s a psychological explanation for this.

Our brain and trading

You probably know that from a biological point of view, we humans are not fit for trading. The main reason for that has to do with our brain, in particular, the primitive part of it – also known as the amygdala. Along with other functions, this is the region of the brain that triggers “fight or flight responses” in situations when we’re at risk of experiencing pain.

Subconsciously, our trading process is heavily influenced by it. How many times have you taken profits too early, or hold on to a losing position, even though the market was communicating a change in the order flow had taken place? Did you at any point avoid allocating time in order to learn more about trading and instead searched for the “easy way out”?

We all do that, and it happens because our brain is designed to help us avoid pain. Financial risk is the problem in our case.

Skills vs. strategy

Trading means anticipating future events and since no one knows how the right side of the chart will look, we need rules to make our decisions – a.k.a. a strategy. The problem appears when people are misled to believe that their strategy is all that matters. Larry Williams, a popular trader, turned $10,000 into $1 million in a year and some of his strategy rules are now public. Will you be able to have the same results now? Absolutely not. Even he tried a second time and the returns were way smaller.

Strategies can’t work every time, meaning skills are the main ingredient for success. Does it matter if you know the rules of a false breakout strategy if you have not yet mastered how to read the order flow behind the price action? Will you be able to generate consistent returns without managing risk properly?

Probably not. Skills and strategy both work well intertwined and instead of just searching for the right winning formula, design a longer-term plan that will help you develop some skills. If you are struggling to have trading results, take some time to reflect on what you do, or even ask for some advice from a trader who already does what you want. Practice and diligence will put things on the right track eventually.

An Introduction To CFDs

The contract for difference (CFD) offers European traders and investors an opportunity to profit from price movement without owning the underlying asset. It’s a relatively simple security calculated by the asset’s movement between trade entry and exit, computing only the price change without consideration of the asset’s underlying value.   This is accomplished through a contract between client and broker, and does not utilize any stock, forex, commodity or futures exchange. Trading CFDs offer several major advantages that have increased the instruments’ enormous popularity in the past decade.

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How a CFD Works

If a stock has an ask price of $25.26 and the trader buys 100 shares, the cost of the transaction is $2,526 plus commission and fees. This trade requires at least $1,263 in free cash at a traditional broker in a 50% margin account, while a CFD broker formerly required just a 5% margin, or $126.30. A CFD trade will show a loss equal to the size of the spread at the time of the transaction so, if the spread is 5 cents, the stock needs to gain 5 cents for the position to hit the breakeven price. You’ll see a 5-cent gain if you owned the stock outright but would have paid a commission and incurred a larger capital outlay.

If the stock rallies to a bid price of $25.76 in a traditional broker account, it can be sold for a $50 gain or $50/$1263 = 3.95% profit. However, when the national exchange reaches this price, the CFD bid price may only be $25.74. The CFD profit will be lower because the trader must exit at the bid price and the spread is larger than on the regular market. In this example, the CFD trader earns an estimated $48 or $48/$126.30 = 38% return on investment. The CFD broker may also require the trader to buy at a higher initial price, $25.28 for example. Even so, the $46 to $48 earned on the CFD trade denotes a net profit, while the $50 profit from owning the stock outright doesn’t include commissions or other fees, putting more money in the CFD trader’s pocket.

Spread Betting vs CFD Trading

Purchasing shares often seems like the obvious choice when looking to invest in the markets.

Whilst shares have their advantages, financial derivatives such as spread bets and contracts for difference could be an interesting alternative or addition to your portfolio.

Financial Spread Betting, What is it?

Spread betting comes down to you predicting the market movement of an instrument. For each point move in your favour, you profit. And for each point move against your position, you incur losses.

You never own the underlying asset, enabling you to bet on both rising and falling share prices. For UK-based traders, this also means you don’t have to pay Stamp Duty or Capital Gains Tax as you would when trading the traditional markets.

The main charge for trading comes from the difference between the buy and sell price (the spread). When you choose a financial spread betting provider, tight spreads mean a lower cost to place your trade.

Read:

CFD trading, what is it?

A Contract for Difference (CFD) is a financial derivative where a trader agrees to pay or receive the difference in market price of an instrument from when the trade is opened to when it is closed.

Similarly to spread betting this enables you to profit (or incur losses) whichever way the markets move. CFDs are often used as a way of hedging your portfolio in the traditional markets.

When you place a CFD trade, you will usually be charged a commission by your provider. Besides this you will pay the spread cost on each transaction.

What are the main differences between spread bets and CFD trades?

Tax: CFDs are liable for UK Capital Gains Tax (CGT), whilst financial spread betting normally isn’t. However, this does mean you can offset your losses in CFD trading against your CGT liabilities. (Note: Tax laws are subject to change and depend on individual circumstances, as such we encourage you to seek independent tax advice. If spread betting is your main income you may be liable to pay tax on your earnings.)

Units and Stakes: In CFD trading you buy or sell a certain number of units in the currency of that specific instrument. This means you may lose or gain money due to exchange rate fluctuations. In spread betting you simply place a stake in your currency of choice.

Expiry Dates: CFD positions are not time-limited. Spread bets often have fixed timescales varying between intraday, short, medium and futures trading. In spread betting a provider can close out your position at the end of this timeframe.

Commission: Most of the charge for trading spread bets is included in the spread, though some traders will pay charges such as overnight financing charges. CFD traders are charged a commission in addition to the spread.

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