CFD stands for Contract for Difference. It’s an instrument that allows you to trade the movement of an asset or market index, but without owning it. You can thus create long and short positions on stocks, commodities, currencies, indices and other instruments traded on the financial markets.
A long position is when you buy a CFD contract representing shares in a company. The value of this position will rise when the share price rises. If you sell your long position, you can calculate any profit/loss made by deducting the price you sold from the purchase price.
You create a short position when you borrow a security from another investor and sells it or “shorts” it. The value of this position will rise when the share price falls. If you buy back a short position, you can calculate any profit/loss made by deducting the purchase price from the sale price.
Trading CFDs can be part of your overall investment strategy if you have a long term view of an instrument. For example, you could use CFDs to trade currency pairs denominated in USD, which would allow you to take advantage of movements in the pair without having to own dollars (which may not be possible for non-residents outside the US).
It’s important to note that because CFDs don’t give you any rights to the underlying asset, you can end up incurring losses that are greater than your initial investment. For example, if Bitcoin goes to $0, you can lose all of your investment because Bitcoin CFDs have no value outside the Bitcoin/USD market. Saxo can help you incorporate long and short positions in your CFD trading strategy.
Long Positions in your CFD strategy
Dollar-cost averaging
Dollar-cost averaging is used to reduce the impact of volatility on your buying power by breaking up more significant transactions into many small ones over time. If you want to spend $4000 on bitcoin, rather than investing all of it, break it into 20 chunks of $200 and invest them at different times. It reduces the average price you pay for bitcoin because when the value drops (as it often does), you’ll be able to buy more units of bitcoin with your same dollar amount; conversely, it will give you fewer units when the value rises.
Catching falling knives
Catching “falling knives” refers to buying something as soon as it has dropped in price significantly without first determining its value concerning other things. The idea is that the price drop will signal a “deeper” or “more fundamental” problem that will lead to further drops, meaning you are buying at a low price. But investors who catch these knives are often actually just reacting emotionally. For example, if Bitcoin has dropped 50% from $10000 to $5000, it could be due to many reasons (or no reason). If your strategy for CFD trading involves catching falling knives, stop and ask yourself: Is this investment still worth making?
Short positions in your CFD strategy
Sell first, asking questions later
If you think something is overvalued, it can be worth shorting if you think its price will drop. This approach of selling first and asking questions later can lead to considerable losses if the market doesn’t follow your predictions or if the asset continues to rise in value. For example, imagine you borrow $1000 worth of Bitcoin at $10 000 and sell it immediately for $10000 because you think the price will fall back down soon. If it rises to $15 000 instead, that’s a loss of $5000 straight away without even considering costs. Be careful with this strategy!
Short squeezes
A short squeeze happens when a heavily shorted stock moves sharply higher, forcing more short sellers to close out their short positions and adding to the upward pressure on the stock. It can dramatically affect your returns in CFDs because if you sell without considering the price of the asset, any increase will result in losses for you. It is a riskier position to take on because you’re predicting that the price will drop below your sale price, but not by enough for you to make a profit. If it doesn’t, then the short squeezes can be very painful/unprofitable for you.
