Traditional and CFD Trades
Finance

Important Differences Between Traditional and CFD Trades

An investor has several options when dabbling in the financial markets. The traditional approach is presupposed upon price appreciation over time. Using the above chart of the TSX index as a case in point; an investor entering the market on November 5, 2023, would be greatly satisfied with the index’s performance to the present on February 12, 2024. The price appreciation per unit of time is positive, resulting in profitable returns.

However, the trading cycles before November 6 were characterized by significant whipsaw price movements, with dramatic peaks and troughs every couple of weeks. Depending on the investment timeframe, such economic performance is not conducive to long-term profit realization, ceteris paribus. Of course, the situation is vastly different when trading. The timeframe for trading activity is significantly shorter than investing (a long-term endeavour).

As we focus on the short term, important distinctions between trading and investing must be drawn. This warrants a different approach for each discipline. Traditional models necessitate real price appreciation (taking inflationary pressures into account). Yet, this is not always possible in a choppy market where volatility is exacerbated by geopolitical uncertainty. We see universal evidence of this, with conflagrations between Russia/Ukraine and Israel/Hamas, with tension stirring between China/Taiwan, and sabre rattling between North Korea/South Korea.

Contrarian Options for Traders and Investors

In the face of growing uncertainty and a burgeoning need for profitable alternatives, traders are turning to CFDs as a viable solution. While CFDs are not advised for every type of trader or investor, they certainly provide inherent benefits by their nature. For example, CFDs (contracts for difference) allow Canadian traders to buy or sell contracts of underlying financial instruments – such as indices, commodities, stocks, and currencies – without owning the asset. This means that a derivative product is ‘derived’ from the financial instrument’s price.

The benefits of CFD trading include generating returns in rising or falling markets. The trader forecasts future prices relative to the price of the CFD contract. The trader or investor will realize gains if the assets perform according to expectations. Incorrect assessments result in losses. The important point to remember is leveraged trading with volatile CFDs is risky. Magnified profits or losses can result, and margin calls may be required to keep trades active.

The above chart is an ideal example of how CFDs may serve as a hedge against a traditional investment in the TSX. Suppose we assume that an investor with a long-term POV seeks to shore up profitability by using a CFD. In that case, that individual may trade CFDs to the downside everywhere you see periods of volatility marked by red candlesticks. During those periods, additional profits can be generated in short-term trading cycles, provided the trader calls it correctly. These are self-evident across the following dates, et cetera:

• November 6 – 12
• November 20 – 27
• December 1-17

Analysis of CFD trading is not restricted to stocks. It exists as a viable option for a wide variety of financial instruments, including crude oil. The price of Brent crude oil continues to decline – currently at $82.19 per barrel, but in October and November 2023, the price was pushing the mid $90 range.

Traditional investors could protect against downward revisions in price by placing CFD put options, which forecast a decline in prices. By holding onto the traditional investment, a CFD put option on crude oil can hedge against losses and boost profitability over the short term. It’s effectively a way to gain, irrespective of the direction of price movement.

Important to Remember

CFD trading, while offering opportunities for profit through leverage and market movement, requires a firm grasp of trading fundamentals and strategic risk management. Platforms like Friedberg Direct powered by AvaTrade technology offer a regulated trading environment, comprehensive educational resources, and sophisticated trading platforms, facilitating an informed trading journey.

It’s always best to start with a demo trading account. This can help novices acclimate without financial risk, and leveraging educational materials and risk management tools can enhance trading efficacy. This approach helps capitalize on market opportunities and safeguards against volatility, making informed CFD trading a calculated venture into the financial markets.

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