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Trading mistakes are often made by even the most experienced professionals. Most blunders made by traders come about as a result of a lack of research, data or discipline. Whilst it is very vital learn from your errors, it’s even better and far cheaper to learn from the mistakes of other people.

Below are a few of the more common mistakes made by CFD traders:

1. Too much Gearing.
One of the major benefits of CFD trading is the ability to gain exposure to a share, index or foreign exchange contract with a relatively small capital outlay. Rather than paying for the total notional value of the CFD position CFD traders can enter into positions with margins as low as 5% or even less. You will need to note that even though a smaller capital outlay is necessary to open the position the CFD trader is still subjected to the price movement of the equity CFD for the full notional value of the position. A Contract for difference trader trading a CFD at 5% margin is leveraging their opening outlay by 20 times, meaning a $5,000 deposit might be utilized to open a $200,000 CFD position.

As only a fraction of the face-value of the trade is outlaid when trading Contracts for difference a tiny price change might lead to significant gains and also significant losses. For example when trading a CFD on a margin of 5%, a price rise of 1% in the underlying instrument may lead to gains of 20%, on the other hand, if the price fell by 1%, it may result in a loss of 20% of the total amount required to open the position.

You will need to keep in mind that gearing is often a double-edged sword not only can it work for you but if not managed correctly it may also work against you, often beginner trades take no notice of the fact that if unmanaged leverage can result in considerable losses.

2. Not understanding the impact of trade sizes on your account
Because of the gearing related to Contract for difference trading, relatively small outlays can lead to substantial moves in your overall account balance.

For instance buying 10,000 CFDs priced at $2.40 with a margin of 5% necessitates an outlay of only $1,200. With an outlay of only $1,200 you can hold a $24,000 CFD position. Should the value of this position go one cent it is going to have an effect of $100 on the profit or loss on the traders account.

If the buy price of the this position increased by 12 cents a profit of $1,200 would have been made. But, if the value of the position fell by the same amount a loss of $1,200 would have been made.

The impact of any price movement will depend upon the traders overall account balance. For a trader with an account balance of $1,500, the aforementioned trade would have had a significant impact on the traders account profit and loss. Should a trader with an account balance of $40,000 take the exact same position the effect would be much less significant.

A loss of $1,200 on a $1,500 account would lead to 80% of the entire account balance being lost. But, a loss of $1,200 on a $40,000 account would result in a loss of only 3% of the account balance.

3. Trading in too large parcels
You should calculate the exposure of your trade size prior to placing the trade. It is common for amateur CFD traders to simply trade the maximum size available to them according to their account balance without taking into account the amount of market exposure associated with the position.

There are a variety of techniques traders can adopt so as to work out position size. A simply strategy is to work out an appropriate amount of risk capital should the trade go against you and calculate an appropriate position size base on this.

In case you wish to restrict losses on any given trade to $200 you would work out your position size based on your stop-loss price. As an example, if the CFD was priced at $1.40 and you stop-loss was at $1.15 your risk amount would be $0.25, to work out your position size you would basically divide the loss you’d be prepared to take by the risk amount. In this instance this would be $200 / $0.25 = 800, therefore your position size ought to be 800 units.

The strategy outlined above is known as fixed fractional position sizing in which a certain percent of the overall account balance is risked on each trade. Other methods incorporate allocating a fixed dollar amount to every trade, buying or selling a fixed quantity of CFDs in each trade or varying the size trades according to the profitability of your account.

Using a position sizing strategy will help you avoid the mistake of placing all your eggs in a single basket.

Many amateur CFD traders start trading the hard way, without learning from experienced traders who have made all of the costly errors traders make on their way to success. To help know the most typical mistakes made by traders and to prevent you from making the same mistakes using your own capital we have outlined a number of common mistakes below.

1. Trading for the incorrect reasons.
Many people start trading with the intention of making a profit from day one. But, there are a few people that trade for fun. Should you be serious about making a return, it’s vital that you treat your trading like a business. Those who trade for fun will be fortunate if they make a profit the truth is more often than not they will lose.

2. Over-Trading.
You must stay away from the temptation to over-trade. Over trading is really a risk for all those traders that aren’t following a strategy, choosing to sit on the sidelines until a clear trend emerges is in itself a valid strategy. You should avoid the mistake of fully gearing your positions just because you have free equity available. It’s also vital to ensure that you do not trade with money that you can’t afford to lose.

3. Psychological and Emotional Mistakes.
Developing the mind-set that you should get every trade right is often a perilous mistake to make if you can’t recognize the very fact that you’re going to make errors and may even find it hard to close out of a losing position. Instead, your mind will find methods to persuade itself that the trade will swing around and happen to profitable. There is a risk that subconsciously you could become blind to evidence that implies that you are incorrect.

You need to acknowledge that you will not get every trade right and that you don’t have to get every trade right, this will let you deal with your trades effectively. Being in the incorrect is something that we frequently feel terrible about. We are taught through positive reinforcement that we should always feel excellent about being right. This often presents problems when trading.

Losing trades may cause emotional distress and stop you from properly analyzing the market. This can present a danger that you’re going to commence over-trading so that you can make back losses or to “get even” with the market. On the flip-side, winning trades can generate feelings of elation and invincibility. If you make the error of permitting this emotion to take hold, you might find yourself taking unnecessary risk or making stupid errors through negligence.

You should aim to keep your trading related feelings under control. Wise traders will focus on the downside risk potential of each trade and will make sure that this is within their pre-defined parameters outlined in their trading strategy.

4. Not understanding the suitability of Contracts for difference.
Trading CFDs has enhanced the trading opportunities for a fantastic many retail traders. Contracts for difference are a perfect product for traders with a small-term time horizon as well as a desire to increase their market exposure on a small amount of capital.

CFDs are not always suitable for long-term traders due to financing expenses which can build up over time. Furthermore traders who do not monitor their open positions won’t find CFDs suitable. You always need to ensure that the sum of money which you allocate to your trading account is an amount that you could afford to loose.

Before you start trading Contracts for difference you should know the negative aspects connected to the product. Like all leveraged financial products, the risks are going to be higher if you don’t take the time to know the product.

For traders that are familiar with how CFDs work and learn to minimize their risks, there are usually considerable benefits from CFD trading. Through the use of leverage and the efficiency of trading, retail traders now have greater opportunities than they have ever had before.

CFD stands for Contract for Difference, CFDs are a financial agreement made between a buyer and seller to make excellent the profit or loss incurred between the CFD was bought to when it was sold. CFDs are well loved in both Australia as well as the UK, they are mostly offered over indices, shares and currencies.

In the early days in London where CFDs started out they were commonly known as SWAP contracts. It wasn’t until around 2001 that CFDs became well loved with retail investors. It was CMC Markets and IG Markets, two large spread betting businesses based in London that bought CFDs to the forefront in the retail trader’s arsenal. CFDs quickly became well loved in the United kingdom as they didn’t attract any stamp duty.

In 2002 both CMC Markets and IG Markets opened offices in Australia and started to actively promote CFDs to Australian traders, the popularity of CFDs peaked in 2007. Because of their popularity amongst Australian traders and investors many international CFD providers saw the potential in Australia and opened up offices. There are over 13 CFD providers operating in Australia and an estimated 35,000 retail CFD traders.

In recent times CFDs have received much negative media hype because of traders incurring losses due to overexposing themselves to the market during volatility. This combined with the recent folding of CFD provider Sonray Capital Markets has led to increased scrutiny by the Australian financial Services Regulator ASIC relating to how CFD providers handle client money.

At present CFDs continue to be probably the most widespread financial product for retail traders in Australia, although unconfirmed it’s estimated that CFD volumes account for around 35% of ASX exchange turnover. As CFDs are an over-the-counter product it is hard to verify this figure.

CFDs in Australia are largely traded over the internet through a variety of proprietary CFD trading platforms offered by the major companies. Many of these platforms had been initially developed for forex CFD trading but due to the similarities between share CFDs and forex CFDs the platforms have be tailored to suit share CFD traders.

As Australia has the highest proportion of share ownership in the world on a per capita basis it’s not unexpected that nearly all CFD traders have experience buying and selling stocks online. The past growth of the Australian share market has made share and CFD trading a widespread pass-time for Australians.

Before you run out and join the 35,000 Contract for Difference traders in Australia you must make sure that you are fully aware of the risks involved in CFD trading. Like all leveraged financial product CFDs offer considerable rewards but these don’t come without risk. You should make sure that prior to jumping into CFD trading you know the Product Disclosure Statement (PDS) available from your CFD provider that outlines the negative aspects and benefits of trading CFDs.

Like all financial products there are risks in buying and selling CFDs. Risk is generally related to profits, the riskier the investment the higher the possible returns, but if risk is managed correctly it can be significantly reduced. When buying and selling CFDs this can be done with the utilization of stop-loss orders and simple portfolio hedging. This article clarifies the key risks linked to trading CFDs and what can easily be done to decrease them without having a bearing on the substantial returns that CFDs can provide.

Prior to trading CFDs you should know that CFDs are a leveraged product and can work for you as well as against you. Like all leveraged products a small price movement can result in large returns but also considerable losses. The variety of order types offered to CFD traders permit the risks associated with adverse price movements to be considerably reduced as CFD traders are able to set their order at a price which they are prepared to close out their position and realize a loss. Everyday order varieties used to mitigate risk are stop-loss orders, trailing stop-loss orders and guaranteed stop-loss orders.

Stop-loss orders
This is one of the most well loved order type employed by traders to deal with risk. A stop-loss order is simply an order to close an existing open position that is placed at a price beneath or greater than the current market price. The order is placed at a price that the CFD trader is prepared to shut out their open position. It’s vital to note stop-loss orders are usually vulnerable to slippage should the price of the CFD gap, this is a regular occurrence when trading share CFDs.

Trailing Stop-loss orders
Trailing stop-loss orders are comparable to stop-loss orders with the exception that the price of the order moves in accordance with a pre-determined distance from the present trading price, this distance is set by the trader at the time of placing the order. It’s essential to note that the price of the order will only alter if the price of the instrument moves in a favorable direction, should the price go against the trader the price of the trailing stop-loss order is not going to vary. This order type works in a similar way to a ratchet, in that it can be utilized to lock in gains as the position moves in favor of the CFD trader without the need for the trader to continually change the price of the stop-loss order.

Guaranteed Stop-Loss orders
Guaranteed stop-loss orders have grow to be commonplace in recent times because of traders having the ability to predetermine their losses. This order type is generally used when trading share CFDs simply because share CFDs are prone to slippage and gapping during the opening phase of the market. It is vital to note that when using guaranteed stop-loss orders your CFD provider will often charge you a premium, this is exactly like an insurance premium guaranteeing that you’ll be filled at the price your stop-loss order is placed.

Other than using orders to manage your risk when trading CFDs many traders use other financial products such as shares and options to hedge their CFD positions.

Shares are generally utilized to hedge CFD positions or vice versa, these are often utilized by traders that hold a portfolio of stocks and also a small term CFD trading account. CFDs are used to trade the small term price movement of the stocks within their portfolio without needing to sell the stocks and realize any capital gains.

Options are employed by some CFD traders as a type of guaranteed stop-loss. Options have an advantage over guaranteed stop-loss orders in that they’re often cheaper. Hedging CFD positions using options is a common strategy utilized by more advanced traders that know the core components of an options contract and know how to pick the most suitable contract to hedge their CFD position with.

Aside from managing risk using order varieties and hedging methods all CFD traders should make sure that they adopt strict money management strategies, meaning that they must not utilize too much leverage or over expose themselves to one individual CFD or sector. Utilizing excessive leverage is the single most well loved error made by novice CFD traders.

Prior to opening a real CFD account you ought to ensure that you practice buying and selling on a demo account to so that you are familiar with how to utilize the various order types available that will enable you to manage risk. Remember CFD trading is often very satisfying if the risks are controlled.

Direct Market Access or DMA is the term often used to clarify a kind of CFD that has grow to be prevalent in the Australian market, these are often known as DMA CFDs. With DMA CFDs your deal is passed directly through to the underlying share market with no dealer or market maker involvement, which means orders are executed at the genuine market price and in a timely manner without re-quotes. Trading DMA CFDs is very similar to trading shares over the internet.

DMA CFDs offer complete order transparency. Traders are able to participate in the market depth of the underlying equity over which the CFD is based by joining a bid or offer queue and also the open and closing auction phases of the market. DMA CFDs offer all the benefits of buying and selling shares with the additional leverage that CFDs offer.

Buying and selling DMA CFDs is very similar to trading shares, traders are able to hit the bid or offer or join the buy or sell queue. DMA CFD traders have significant advantages over traders using market made CFDs for the reason that they have got the potential to enter and exit trades at better rates.

When trading DMA CFDs you will be required to subscribe to exchange data, the price of data varies from exchange to exchange. Once subscribed you will have access to real time rates and market depth allowing you to see the amount of buyers and sellers at each different price level and take part in order queues allowing partial fills and better execution.

One shortcoming of DMA CFDs is that guaranteed stop loss orders are not offered, but these are not always necessary as generally DMA CFDs traders use options to deal with their downside risk but these are usually overly complex for the amateur trader.

When buying and selling DMA CFDs traders have the ability to be price makers meaning that when an order is placed it’s transmitted to the real market and can affect the value of the stock on which the Contract for difference is based.

Trading CFDs using a Direct Market Access (DMA) model is best suited for frequent traders that trade on an intra day basis. Frequent traders will find that Direct market access CFDs will allow them to buy and sell freely without dealer intervention and obtain better prices when buying and selling. DMA CFDs are suited to active day traders and scalpers who are looking to make the most of small price changes quickly.

There are a variety of CFD platforms that you can trade DMA stock CFDs on, the two most common platforms in Australia are webIRESS and ProDeal. Both platforms allow customers to take part in the market depth of the DMA CFD on which they are trading. The webIRESS platform is also extremely well loved throughout the share trading community, largely because of the diversity of order types on offer, whereas ProDeal is very common amongst CFD traders, this is because of the broad range of CFDs on offer and its superior charting functionality.

It’s vital to note that prior to starting to trade DMA Contracts for Difference you you reckon about whether this sort of Contract for Difference fits your trading style, choosing the incorrect CFD variety will have an effect on the success of your trading plot.

There are numerous CFD brokers in Australia to select from, meaning CFD traders have a series of options, but choice can be confusing. Here we will provide you the CFD trader with an summary of the key differences of each CFD provider being their software. Time and again newbie traders become overwhelmed by the variety of trading platforms to choose from and can often become perplexed by the vast array of financial products some companies offer on their CFD software package and neglect to take into account whether or not the software fits their trading plot. This review will help you choose on the right CFD platform that fits your trading technique without needing to install multiple demonstration trading platforms.

Deal book 360
Deal book 360 is the CFD and Forex trading platform offered by GFT, the software is a downloadable application. Once you open the trading platform the original thing that you will notice are the charts, this platform has fantastic charting functionality. I tested the graphs for both Forex and CFDs and found the foreign exchange graphs to be right and consistent with those on other CFD trading platforms in the group. When evaluating the CFD graphs to others in the group I observed that the rates did not always reflect what the others showed, this is probably because GFT is a market marker and their rates are not an accurate reflection of the underlying instrument on which the CFD is based. If you searching for a respectable Forex charting package that is free GFT can offer you this in their deal book 360 software, but I recommend that you stay away from the CFDs on the software.

Pure Deal
Pure deal is the internet based CFD trading platform used by IG Markets, the software is web based, straightforward and simple to use. I gave this trading platform a excellent trial run, what I liked about this software was that there were so many instruments to trade, the downside of this but was that a lot of of them did not suit my trading plot and after a while the complicated instrument search tree grew to become frustrating especially when I wanted to get a CFD position on quickly and the CFD was not in my watch list. The charts on this software are incredibly plain and if you want more complex charts you have to pay for them. Aside from the distress with the CFD instrument tree the software is a first-class all round trading platform for the novice trader that wants web based software. For someone that requirements that small extra in their platform Pure Deal would not be a sensible option.

Web IRESS
The web IRESS platform is obtainable from Comsec and Etrade in Australia, this trading platform was one of most suitable in the group when it comes to trading DMA CFDs. The trading platform is web dependent and simple to use, it has various advanced order types like trailing stop loss orders which are fantastic for CFD trading. The downside of this software are its charts, they are basic with very the minority indicators. If charts are not vital to you and you are searching for a CFD trading platform that will offer you DMA CFDs on ASX listed CFDs over the internet this would be a fantastic selection, though it comes at a price. Equally Comsec and Etrade will charge you around $55 per month to use this software, this combined with $38.50 in exchange royalties makes this software an expensive proposition given there are other trading platfroms out there can offer you the similar and even better features for free.

Market Maker
The Market Maker platform is offered by CMC Markets, the trading platform is downloadable and has some terrific features like being able to back test on 10 years worth of past price data. This was the most hard trading platform of those reviewed to install, the download file was huge. Once I was up and running, I found the interface very user friendly and the charts simple to use, but after being logged into the software for 30 minutes the charts froze. Once I was back up I checked the prices of some ASX CFDs against the other trading platforms and noticed that price changes on the platform lagged by about 2 seconds. My experience with the market marker platform was less than enjoyable and I can’t imagine that the troubles were isolated to my PC. This is a trading platform that I recommend you stay away from, from my personal experience it is plagued with technical issues, the worst nightmare for any online CFD trader.

Pro Deal
The Pro Deal trading platform is offered by International Capital Markets (IC Markets), the platform is downloadable but also has web and mobile versions. This was the simplest CFD trading software of the lot to set up. Once the software was established the quick start videos guided me through the workspace setup. The workspace was effortless to navigate and not cluttered with CFDs that I would never trade. The platform has both DMA CFD as well as over-the-counter (OTC) CFDs, with both varieties I was able to trade the ASX cash and day trade using DMA CFDs watching my orders flow onto the underlying market. The charts on the trading platform have multiple indicators, and are not overly complicated to use. The best thing about this trading platform is that it is free.

So which CFD trading platform is for you?
Following my evaluation all five platforms it is simple to see that every trading platform has their niche. If you trade Foreign exchange Deal Book 360 would be the one for you, if you like uncomplicated web based software go for Pure Deal, if you just trade ASX CFDs then web IRESS (although expensive) may well be for you, but if you want an simple to use and reliable all round online trading platform you can not go past IC Markets Pro Deal software package.

Before trading contracts for difference you must always know how to use the CFD platform you choose on, bear in mind that the best CFD software for you will depend completely on your trading style. You should Install a Pro Deal CFD demo, the trading platform that I have chosen to use, and see if it is the right CFD platform for you.

What’s a Contract for difference?
A CFD (Contract for Difference) is an agreement involving a buyer and a seller to swap the difference in value of a particular instrument between when the contract is opened and when it is closed. The difference is determined by reference to an underlying instrument which is usually a share, index, foreign exchange rate or commodity and the period over which the Contract for difference is held.

CFDs are geared financial products. This means that you will be fully exposed to price actions of the underlying instrument without needing to pay the full price for that instrument. Leverage means that CFDs offer the possibility to make a higher return from a smaller initial cost than investing directly in the underlying stock.

Leverage, but, usually involves more dangers than a direct investment in the underlying instrument. It is imperative to recognize that this effect may work against as well as for traders. The use of leverage can lead to large losses in addition to large gains.

Benefits of dealing in CFDs
CFDs have been used by professional traders for over twenty years and emerged originally as an over-the-counter (OTC) product. CFD related dealing and hedging is one of the fastest developing areas in the Australian and European derivatives markets. This acceptance has arisen as a result of the following main features:

Leverage
CFDs enable you to gain full exposure to a share, commodity, FX cross or index for a fraction of the price of buying the underlying. CFDs call for only a small initial margin to secure a position.

The capability to go ‘small’
CFDs permit traders to take advantage of falls in prices. This means that investors can profit when prices are going down, not just up. CFDs are thus an brilliant investing and hedging instrument.

Simplicity
Non-expiry: The majority of CFDs do not have an expiry. They are perpetual in nature. For CFDs that do not expire, the only way to close a trade is to trade the opposite side of the position.

The CFD mirrors the price of the underlying: Unlike other forms of derivatives (i.e. options and futures), cash flows such as carry costs and dividends are not mirrored in the cost of a CFD. Instead, cash flows are paid whilst the trade is open, allowing CFD prices to follow the underlying instrument rather than trade at a discount or premium, as can be the case in other varieties of derivatives.

Advantages of ASX Listed CFDs
Market Independence
ASX is obliged under the Corporations Act to ensure that its markets are honest, orderly and transparent. ASX ensures a sound operational and front-line regulatory environment for its exchange-traded markets and clearing and settlement facilities, providing effective systems and infrastructure together with services designed to preserve and improve the integrity, efficiency and effectiveness of its trading, clearing and settlement facilities. For the ASX Listed Contract for difference trader, this means being able to participate in the market with assurance.

As the principal market operator, ASX is independent of the parties with whom you are receiving recommendations and dealing through enabling it to act honestly and independently. This separation of accountability between broker and exchange also offers traders with selection as to whom they wish to do their business through.

Going through a central market also means there is one standard contract specification for all ASX Listed Contracts for difference, not a different product depending on who you do through. It’s a fundamentally better Contract for difference market.

Transparency
Transparency is a main ingredient in a well informed market. ASX reports on all ASX Listed CFDs transacted, open positions, bid, offers and their volumes. In fact, all the market information you are used to seeing from the ASX. This means a better informed market.

ASX Listed CFDs are traded in the same way as other ASX traded contracts:
1. All prices are formed in a fully transparent manner in the ASX’s CFD central market order book. Each trader’s order is pooled in the ASX Listed CFD central market order book with those from other market members, including market makers, and becomes an integral part of the price discovery process.
2. All deals are executed on a strict price/time priority. Price/time priority means the first person to enter the best price is traded against first. This results in everyone in the central market order book being dealt with honestly and consistently, no matter how huge or small a trader you are.
3. Importantly, whilst prices are transparent, the individual investor remains anonymous, which minimizes market impact expenses (especially those related to other people recognizing an individual’s investing patterns and trading ahead of him/her).
4. Anyone can place into the market a better bid or offer, as is the case in all exchange based markets. No-one is forced to accept the price offered in the market. But, once an order is executed, you are committed to settle the trade. All prices in the market are firm in the amount indicated.
5. The ASX Listed Contract for difference central market order book incorporates orders from market makers. Their actions help guarantee the ASX Listed CFD market has competitive prices and deep liquidity.

Risk Management
ASX Listed Contracts for difference trade in a centrally cleared marketplace. The Clearing House offers central counter party clearing for the ASX Listed CFD market. This involves the Clearing House managing risks to ensure that the interests of its Participants and clients are protected and that the integrity of the marketplace is maintained.

Through a method called novation, the Clearing House becomes the principal to all trades and liable to perform against all contracts to which it is a party and effectively ‘guarantees’ performance to other Clearing Participants. Novation and thus the clearing guarantee become effective on registration of the agreement connecting a buyer and seller.

This exposure is then handled and the clearing guarantee established in a variety of ways. Initially this is often achieved by the collection of the various margins. The collection of these moneys protects against extreme price changes and prevents participants from accumulating large unpaid losses that could possibly impact on the financial position of other market users. This is a key element that differentiates exchange-traded markets from over-the-counter (OTC) markets, where such a strict margining regime is not in place.

The ASX Listed CFD market also has access to the Clearing Guarantee Fund designed for use in the event of failure of one or more Clearing Participants.

Transacting in the ASX Listed CFD Market
When trading ASX Listed CFDs, your order is entered directly via a participant into the ASX Listed CFD central market order book. This order book is available for the market to see. All orders are executed on a strict price/time priority. This means that the first order with the best bid or offer price is always executed first. Trading in the ASX Listed Contract for difference central market order book also ensures “customer instructions” are always given priority above a broker’s “house orders”.

In contrast, customers executing CFDs using an Over-the-counter broker, do not have their orders in the ASX Listed CFD central market order book. These orders are transacted with the Over-the-counter CFD counterparty (typically described as a Contract for difference Broker). The customer’s order is not protected by the ASX’s price/time precedence or customer order precedence rules.

To find out more about ASX contracts for difference you ought to download this CFD education which clarifies ASX contracts for difference in detail as well as how they are margined, priced, cleared and how you can go about finding a broker that is able to offer you the world’s first exchange listed CFD contract.

Pairs trading is the action of a investor going long one CFD and simultaneously going small another. As the investor is long one CFD and small the other they are not affected by broader market price movements instead they are subject to the price changes of the pair of stocks which they are trading. As long as the trader buys the outperforming security or sells the under performing security they will generate profits.

Most traders buy Contracts for difference with the view that the market will rise, few traders take sold positions with the expectation the market will fall. Pairs traders do not care about market trend and do not mind which direction the market moves so long as they choose a strong pair of related stocks.

Pairs trading has become well loved since the introduction of CFDs, prior to this it was not simple for a investor to small sell. CFDs have made pairs trading simple and accessible to the everyday trader.

Most investors take up pairs trading strategies when there is uncertainty as to the trend of the market. The rationale for this is that it eliminates market risk, whether the trade generates profits will depend on whether the trader goes long a Contract for difference that will outperform or sells a CFD that will under perform. A common example of this would be buying Commonwealth Bank (CBA) and going small ANZ Bank (ANZ), because the trader expects that CBA will outperform ANZ. Should both stocks rise or fall the trader will be indifferent, but should CBA rise and ANZ fall as the trader anticipated, the trader will generate profits. If CBA falls less than ANZ the trader will make money likewise if CBA rises more than ANZ the trader will also make money.

There are a number of benefits of using Contracts for difference in your pairs trading strategy. One of the main benefits is the financing offset that will be achieved when the trader earns a financing revenue on their small position. Take the above example for instance, when the trader opens the long Contract for difference position on CBA they will pay a small financing charge but when the trader sells the ANZ CFD they will receive financing income. Although the offset is not 100% it will most certainly reduce the cost of the trade. In many ways pairs trading as a small to medium term strategy and can be cheaper and less perilous than simply opening a naked long or small position.

Pairs trading is not only commonly used when trading equity Contracts for difference it has also become extremely common for use with indices. When using Contracts for difference over indices investors can take the view that one index will outperform the other. An illustration of this may be the US market versus the Australian market. In this example you would buy the ASX 200 index Contract for difference and sell the S&P 500 index CFD with the expectation that the Australian market will outperform the US market.

Pairs traders adopt a number of strategies, one of the more common strategies used is to pick pairs that are associated, for example Stockland against Mirvac or Rio Tinto against BHP Billiton. It is also common for investors to use sector Contracts for difference in their strategy such as the health care sector versus the materials sector or energy sector versus the ASX 200 index.

An example of sector trading would be the resources sector versus the ASX 200 index. The trader might be of the expectation that the resources sector is overvalued relative to the market and will under perform the market, the trader would small the resources sector and buy the ASX 200 index. Alternatively the trader may feel that the market will retreat and funds will go back into the defensive stocks, in this case the trader would buy the health care sector and sell the energy sector. When choosing sectors the trader should consider their weighting within the total index as this will help the trader choose the sectors correlation to the overall market. Pairs trading can be done on nearly any financial instrument but currencies which by their very nature are allready a pairs trade.

To find out more about Contracts for difference visit our pairs trading page and download our educational guide.

CFD Margin requirements
An initial margin amount is required to open a CFD position, either long or small. There are two kinds of margins which are applied to the total value of a Contract for difference position. These are initial margin and variation margin.

Initial Margin
Initial Margin is the initial deposit required to open a position. For Australian equity CFDs, this ranges from between 5% to 50% of the entire notional value of the trade. Therefore, if you bought 10,000 XYZ CFDs at $1.35, you would be required to have no less than $1,350 within your account to cover the minimum margin prerequisite (10% of your total position size of $13,500). The margin prerequisite for index and foreign exchange CFDs can even be as low as 1%.

Variation Margin
Variation Margin relates to the difference between the initial margin and the margin required to maintain the position open as the position value changes. Here is an example if bought 2,000 XYZ CFDs, at $5.60 it would give you a position value of 2,000 x $5.60 = $11,200. Assuming XYZ is margined at 10% you would need no less than $1,120 initial margin to open this position. If XYZ falls to say, $5.40, you will now have a loss of $400 ($0.20 x 2,000). This loss (often known as variation margin) is subtracted from the initial margin of $1,120, leaving a deposit of $720. Since you still hold 2,000 XYZ contracts at $5.40 you will have a margin requirement of $1,080 (i.e. 2000 x 5.40 x 10%). There’s now a paper loss of $400 also, the initial margin has been reduced to $720. This is $360 lower than the margin required to maintain the position open, which means more margin is needed to top up the account. The shortfall in margin is called a shortage in equity. If you cannot maintain your margin requirement you won’t be able to increase your position but you’ll always have the ability to reduce or close a position.

Equity Balances
The equity (or balance) of your account will rise and fall based on the cash you have deposited or withdrawn from your account, the profits or losses within your account and the size of the positions held. Throughout the trading day your account balance, including all open positions, are valued against the prevailing market rate. Therefore your equity balance is constantly calculated in-line or marked-to-market with market movements. Your end of day account balance is calculated using the mid-closing rates (or the last traded price). The equity balance is used to assess your available margin against current positions, and possible new positions you may need to take. Your cash balance is used to ascertain if there’s a requirement for additional margin deposits in your account. Once a CFD trade is opened, variation margin requirement should always be maintained on your open positions. It is your responsibility to make sure that your account is satisfactorily margined at all times, particularly during volatile trading periods. You’ll only be allowed to trade and retain open positions on the premise of cleared funds in your account, not on promised money or funds in transit as a result it’s essential to permit sufficient time for funds to clear when depositing cash into your account.

If a position turns into profit, the increase in the equity of your account allows for further positions to be opened.

Shortage in Equity
A shortage in equity occurs when the account balance falls below the required initial margin. Accounts with a shortage in equity are usually only allowed to scale back open positions, until the equity balance is in excess of the specified deposit. No new positions can be opened until this situation is rectified.

Margin Calls
If the market moves against you and your equity balance falls below your initial margin you normally have the choice of:
i. close a number of of your open position(s), to reduce your initial margin to the required level; and/or
ii. add more money to your account to maintain the initial margin.
This is the initial trigger level for margin, known as the ‘Margin Call’, which you need to add additional funds to maintain your open positions.

Stop Out Level
You will be at risk that your open positions will generally be closed when you have less than 40% of the required initial margin (i.e. 40% of the position size) but this may vary between CFD providers.

Margin, leverage and risk
Margin plus the associated leverage can be very useful if you use it correctly. It can also be devastating to the inexperienced trader that has small understanding of the hazards of using leverage and not using a defined risk management plot. There are several ways of using the leverage available by trading CFDs, from the most conservative to the most aggressive. The way in which you utilize leverage will depend on your personal circumstances.

Prior to trading CFDs be certain to read the Product Disclosure Statement (PDS) that your CFD provider issues as this will clarify in detail how your CFD provider deals with margin. You must also read this free guide to CFD investing, which clarifies leverage and margin in detail.

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Trading breakouts from congestion or trading ranges is one of the toughest parts of trading, particularly when it comes to trading the futures indexes. One reason this area of trading is so hard is because human nature tells us that we should be getting small when prices are trading downward, and that we should be getting long when prices are trading upwards. Unfortunately, what seems natural is what will often get you into distress when trading the markets. What I am about to show you may open your eyes to a new understanding of exactly how to go about trading breakout’s profitably. These entries are all based on price action strategies.

Congestion areas and trading range areas are nothing more than an area where the bulls and bears are in near equilibrium. These areas can be as small as a few ticks, up to several points wide depending on what time frame chart you are currently viewing. For the sake of a mental picture for this article, let’s assume we are looking at a 2000 tick intra-day trading chart, which is somewhat similar to a 5 minute trading chart. I prefer tick charts to time charts for the simple reason that I believe that I can see more details in the price movement, but that’s for another article and another time. Let’s concentrate on trading rages for today.

One of my most vital trading rules is that I can NEVER buy or sell the break out of a trading range. The reason for this rule is that most trading range breakouts fail at least once, if not more than once, before prices will truly start trending again. Remember, a trading range is nothing more than a temporary point of equilibrium in the market. If prices go too far to the bottom of the range, the buyers tend to swamp the sellers, and prices go back up. When prices go near the top of the range, the sellers swamp the buyers and prices start to go down again.

At some point, enough buyers or sellers will join in to push the market slightly higher than the former high, or slightly lower than the previous low, and this will usually make a failed breakout. These failed breakouts, by a tick or so, are very common in the ES and the other mini indexes. One of the most common entry traps will occur when enough buyers or sellers join in to really push prices out of the trading range with a very strong bullish bar, or a very strong bearish bar. Even then, it is very likely that the break out will fail first, and prices will pull back again. The point I’m trying to make here is that most trading range breakouts, no matter how weak or strong they look, will fail the first time out in most cases.

Nothing is ever written in stone when it comes to trading, so sometimes, you will get a break out that never checks up and simply moves strongly in the direction of the break out. It is my opinion that this is the exception though, rather than the rule. A strong breakout will happen only often enough to keep you trying to perfect it, and your trading account funds will more than likely be reduced while trying to figure out how to make it work in your favor. At the very least, you will usually be forced to ride out a pull back with a much larger stop than you would prefer in order to survive the trade.

Now that we have discussed what happens with most trading ranges, let’s talk about how to beat or outsmart other traders when it comes trading these formations. If the overall trading day is simply a larger trading range type day, then it is usually best to fade all breakouts. On the other hand, if the day is a trending day, at some point, prices are likely to break out with the dominant trend, but again, we don’t enter during the break out. The smart entry will be to wait on the break out to fail and start to pull back. Once the pull back starts to lose momentum, we will look to join in if prices turn back with trend again. This is known as a breakout pullback entry, and this strategy is the optimum way to enter a trading range breakout if you want to get on board in the direction of the actual breakout.

By using this strategy, you will occasionally miss a strong break of a trading range, so don’t let that entice you to join in when you see it happening, as it will only happen often enough to keep you joining in on a losing entry strategy. Most trading range breakouts will give you a pull back opportunity to join in later, and if not, the worst that can happen is that you will miss a rare profit opportunity. It’s my opinion that you will lose more money taking first time breakouts than you will ever make trading them, because most will fail shortly after prices break out of the range.

I feel it is vital that we discuss a few additional nuances of trading ranges and congestion areas as well. In most instances, trading ranges will normally start trending at some point in the same direction that they were moving in when they went into the trading range. That doesn’t mean that prices will always resume trending in the same direction, but that is the more common scenario. So, based on this theory, be particularly on guard when prices break out counter trend, as this is most likely going to become a fantastic opportunity to simply fade the break out.

The ES is well-known for failed breakouts with trend, which immediately go to the opposite side of the range, and fail out that side as well, before prices start back moving with the original trend. Stop running is rampant around these trading ranges, and it is best to avoid most entries until prices offer a failed breakout opportunity, or a breakout pull back entry.

While I have given you some vital information on how to go about trading breakouts, there simply is not enough room in one article to discuss this strategy in enough detail to make you an expert trader of ranges or congestion. But, you are now provided with enough information to have a better understanding of what is going on around these formations. There really are only a few basic rules to remember when trading ranges. One, you must never take the original breakout. Two, either fade the breakout, or wait on a breakout pull back before entering. If you start with these basic entry rules, and study what happens closely going forward, you can improve your trading results tremendously. Review a few intra-day trading charts and see if you don’t agree! If you want to learn more about these system trading entries, follow our links to our web site.

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