Category: Tips

One of a series of crucial fundamental lessons of trading of any kind is the importance of being disciplined. As a proposition, it is one that is frequently touted by the pros, and anyone involved in trading education will spout the mantra until their blue in the face. Sadly, many traders still end up learning this lesson the hard way, at the expense of their trading capital and, in some instances, their personal assets. Trading CFDs isn’t a game, and unless you like throwing your money down the drain it pays to listen to the lessons of those that have gone before you to avoid making these very same mistakes.

CFD Leverage and Discipline

Particularly with the unlimited liability of CFDs, maintaining discipline is a central component of keeping your capital in tact and building a profitable, sustainable trading portfolio. Entering trades too early, closing trades too late and getting greedy are all key signs of an undisciplined approach to trading, and they can often be the ruin of inexperienced, new traders, leading to exaggerated losses, under-performing positions and limited profits on the upsides. So too does discipline creep lead to the restraint of stops, and lingering over positions when better judgement and market data indicates strongly in the reverse direction.

Indiscipline can also be seen in traders who flip flop between strategies, and lack both the will power and the perseverance to see through their theories to fruition. Building up a nose for a trade takes time and experience, and it’s inevitable that many early trades will go wayward. Of course, even the most experienced traders in the world can get it horribly wrong – see the recent banking crisis as a prime example of this proposition in action.

Maintaining a cool head and a rational approach to trading is key to entering the right positions and exiting at the optimum times. That means reading market analysis, interpreting the signs and abandoning your dearest held theories and principles when the going gets tough.

Example of Disciplined Trading

For example, with the collapse of Company X, many investors sought to buy shares after the first day’s highly negative trading, on little more than the gut feeling and instinct that the balance sheet was fundamentally sound. Unfortunately, market indicators and external factors were piling up against Company X to make it look far from investible, and those that lacked the discipline to stick to their trading guns and work within the parameters of their strategies bore the brunt of the total collapse in share price over the following few days.

Nothing should be allowed to guide your trading decisions other than cold, hard statistical evidence, and without recourse to the proper data it is impossible to operate on a consistent, rationed basis. While maintaining your discipline is seldom easy, it is critical to get yourself into the mindset of a professional trader and distance yourself sufficiently from gut feeling and hunch to invest on the basis of the evidence in front of you and the trading strategies which will serve you well over the long-term to avoid sustaining overly painful losses in the short term.

A central strand to successful trading is timing. If you were able to enter every trade at exactly the right time, and close out positions at their natural peak in a swift and timely fashion, it would be easy to make tens of millions trading the markets – particularly with CFDs and leverage on your side. Unfortunately, timeliness is rarely a skills that’s so black and white, and it can often be difficult to gauge exactly when to execute on your trading orders. That said, there are some key cues that should influence your response and prompt certain trading decisions, and your management and perspective on timing is central to making this a viable possibility.

Time management in the context of trading refers to understanding when to trade, when to cut your losses and when to lock in your profits. Virtually everything about the execution boils down to timing. If you’re up early enough in the morning to catch the opening flurry, you can bag a quick profit before the trading day finds it rhythm, whereas a sloppy, dithering approach could see you missing out on these crucial few moments.

The last minute rush to buy and sell at the end of the trading day can be a great time to sell your profitable positions or ditch those that are likely to cost you money on opening tomorrow morning, and you can bet your bottom dollar there are traders worldwide sitting waiting for the clock tick to opening time. If you’re not completely on top of your timings, and rigorously managing the timing of your trades, its very possible you’re leaving good money on the table and sacrificing an ideal opportunity to sell losing positions before they fall too significantly.

Importance of Time Management in Trading CFDs

The importance of time management never hits closer to home than when a delayed decision brings an adversity to your trading. As a private trader without recourse to teams of economists and market analysts, your key advantage lies in dynamism, and your ability to take quick decisions on your analysis of key market indicators. If your positions look to have peaked, get out – even if that means coming out just below the actual eventual peak of the position.

Don’t sit around waiting for your positions to recover, particularly if your exposure is leveraged – take your medicine, cut your losses and walk on to the next trade. While it might be painful and contrary to your best judgement and market interpretation, you’ve got to be pragmatic about your trading and cut positions as quickly as practically possible to minimise your losses.

Time management, like maintaining discipline, is something that more often than not only rings true when you’ve sat and painstaking watched a position plummet while you wondered what to do. Fortune favours the brave, even if that means getting it wrong from time to time and cutting too early – there’s much to be said for being a swift actor in trading, and with time your on-the-spot decisions will become more reliable and more consistent, while your ability to manage your timings with individual trades will gradually improve and deliver more generous returns over the long-run.

One of the biggest plagues on new and inexperienced CFD traders is the emotion of a trade, and the feeling that you’ve backed the right position even where indicators are starting to suggest otherwise. Getting emotionally involved in the positions you take is only natural – as humans we tend to think we’re right most of the time and our opinions are the most informed and most valid, to the exclusion of the rest of the world, so to distance one’s self from this mindset isn’t easy. But distance we must, in order to prevent unwarranted losses and a painful reminder that the markets obey no one other than themselves.

Emotional trading can be a financial suicide, and managing the psychological side of the trading game is critical to long-term success. By emotional trading, we mean sticking by your guns and refraining from exiting a position you are convinced will do well. Remember that the markets are comprised of ordinary traders like you – it isn’t a forum for debate. If the movements of the market aren’t rewarding your positions, you need to be prepared to change and go for a different approach. After all, the markets wait for no man, and if you’re caught up in a battle of wills, more often than not you will find yourself on the losing side.

High Leverage and Financing Costs

Never is this lesson more poignant than with CFD trading, where the interplay of leverage and interest costs make holding on to positions beyond their legitimate viable lifespan even more disastrous. Remember that leverage can weigh against you multiple times beyond your initial trade amount, and the excessive costs of funding an increasingly unviable position can lead to the closure of other profitable positions and the dreaded margin-call. That’s a price no trader can afford to pay for psychological satisfaction, and it will be much more painful in the long run to hold on to a position and watch it sink than it would have been to exit with a small loss.

If you take the time to read anything about trading tips and foundational trading knowledge, you’ll probably come across advice to this effect. The sole reason for a cliché, in this sphere or any other, is its basis in truth, and there’s no point in putting blind faith in a position that otherwise shouldn’t merit it.

Disciplined CFD Trading Approach

As hard as it seems, adopting an objective perspective is the only way to ensure a timely, disciplined trading approach – they are not your positions to be held close to your heart, and any trade you execute is only between you and the broker, so don’t get defensive if things aren’t working out.

The mature, and most profitable, approach to trading is to distance yourself from individual positions and analyse your next moves on the basis of market data alone – if the charts are starting to turn against you, it’s up to you to seize the bull by the horns and remedy the situation, perhaps at the expense of your pride but to the advantage of your running trading balance.

Diversification as a principle is primarily aimed at spreading the risk of a negative trade across multiple different asset classes and instruments. The theory underpinning diversity in trading holds that if 1 in 10 positions are likely to falter, it’s better to have 100 smaller positions and take 10 small hits than to have 10 positions with one massive loss, and by thinning out the chances of trading catastrophe by getting a critical trade wrong, you can start to better manage risk while exploring more innovative investment options.

Trading Diversification Example

The importance of diversification of your trading portfolio is explained in the following example. Imagine a trader with a sole investment interest in the banking and financial services sector. Over the last five years, the trader has got to know the inner workings of finance and banking stocks, and feels pretty comfortable in his ability to read the market and the major players within it, backing a number of key stocks across his portfolio. His exposure to the banking sector is 100% of trading capital, leveraging his particular specialisation in the field.

Roll on the banking crisis, and the unprecedented collapse of banking and financial shares. The above trader could foreseeably lose 100% of the value of his trading capital, and even worse if he’s heavily leveraged in these positions.

Consider the same trader, but with an exposure of only 10% to the banking and financial sectors, instead opting to diversify his portfolio across other industries to avoid overexposure. The result? A significant but non-critical 10% hit, with the remaining 90% of his portfolio still in tact to help offset the losses from the now defunct 10%. It is the diversity of the trader in this second scenario that has saved his trading portfolio from total ruin, and that will no-doubt mean he is in a position to continue trading beyond the collapse of one sector.

Applying Diversification in CFD Trading

Of course, diversification is not limited to sectors and industries, but should also be applied across the board to different asset classes and instrument types – even avid CFD traders should take care not to operate solely through the medium of contracts for difference. By segmenting your portfolio into a number of severable chunks which don’t depend on the success of any other, organised into low-risk, medium-risk and high-risk categories, it becomes possible to solidify the foundations of your trading account and minimise the impact of any particular collapse or bad investment decision.

Seeking diversity across your trading portfolio is one of those things that is worth the effort and hassle it brings to safeguard your capital from any one catastrophe. The chances of total economic meltdown are far less than the chances of one particular business or sector experiencing difficulties, and the more diversely you are spread, the more likely you are to avoid the rot.

As a general rule of thumb, you should aim to ensure you are as diverse as you can manage without sacrificing any profit potential, in addition to hedging and setting tight stops to minimise your risk profile and increase your chances of successful trading.