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.

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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.

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.

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