Develop your CFD Trading Plan
- Irrespective of what financial product you are trading, you need to plan your trades carefully before putting capital at risk. When you trade contracts for difference, the leverage factor of these derivatives means that you need to be even more careful. Trading can be straight forward but it still requires discipline. Leave your gambling instincts behind and stick to your rules.
- Have a trading plan! It may be simple but it is quite surprising how many new CFD traders simply dive in without sufficient strategic thinking lured to impatience by the promise of fast, easy monies. This kind of short-sightedness can result in big drawdowns and reduce your capacity to take advantage of new trading opportunities. One of the best-selling trading books is 'Market Wizards by Jack D Schwager' where 16 of the best traders narrate their trading methodology. The systems, methods and markets they trade are different but they all share a common trait - they have a trading plan which they follow consistently.
- You need to formulate a plan and trading strategy you have the discipline to adhere to, such plans vary according to people's personalities, but it needs to be well thought out and tested, with a dry run and then with very small amounts of money; only when this has shown to perform on a consistent basis would I think about upping my stakes. A good trading strategy in which you have confidence should hopefully, at the very minimum break you even. If you aren't sure about whether you have a strategy, odds are that you don't have one and if this is the case you shouldn't be trading.
- Never trade on a hunch or a whim, but identify your target price and invest at the right time. Most investors will enjoy more success from a handful of companies or markets that they watch closely.
- Do papertrade your system until very comfortable and you have enough data to have seen your strategy work well and also collapse completely. Strategies are like broken clocks, in so much as even a bust clock tells the right time twice a day. You need a basic core strategy, which you have, and then you need to monitor the overall market trend and be prepared to make documented changes to your core concept.
- Don't keep searching for the perfect trading method that will always be correct because it doesn't exist - instead it makes better sense to focus on keeping your losses small and your trading methods consistent.
- While CFD traders frequently spend a lot of time selecting, planning and executing new trades, they often make the mistake of exiting these trades with much less thought. This is unfortunate as it is the exit, after all, that will determine whether a trade has been profitable or not. Whether you are scalping, day trading or position trading there are some important factors to consider when building your trading plan -:
There are four main ways that stop losses can be set -:
- Your method. It is important to come up with a trading system (method) you can use over and over again. If you trade without a plan you will find it difficult to work out what happened through pure luck and what occured through good management.
- Your trade entry points. You need to know what scenarios you are watching out for and what conditions will trigger an entry into a CFD position. Don't change your reasons for being in a trade after you get into a position - if you start doing this you can easily end up justifying being in any trade since all you need to do is just change the criteria around.
- Your trade exit points. You need to know under what criteria you will exit a trade and how much you are willing to put at risk before entering the trade. Although you cannot always say with absolute certainly where you exit level will be (due to market gaps), you should be very clear as to what conditions need to be trigger for you to close out your CFD position.
- Your trading diary. You need to keep good track of your trades. Good record-keeping means that when you look back at how you have performed you can easily see the things that you may need to tweak.
- Technical Indicators: Here you analyse technical indicators to determine appropriate stop loss levels.
- Retracement methods: This involves analysing movements in the stock price and placing the stop loss based on a
predetermined reduction in the stock price. e.g. a 7% reduction triggers your exit.
- Volatility based stops: These stops are triggered by the market volatility. A stop order is triggered if trading volatility spikes past a pre-defined level.
- Pattern based stops: Here you analyse trend lines or lines of support. Trend line breaches constitute a good opportunity to open or close a trade.
- Questions and things to ponder about: trading timeframe, money management risk to trade size (how much you would lose if a stop is hit - assume 50% will be stopped), how many of the shares in your watch list could you afford to trade/invest in one go? A larger amount in a few of them or a smaller amount in all of them? When do you enter your trades (how much of a pullback do you want before entering and should the mainstream benchmark index such as the FTSE (in the UK) also be pulling back or does that not matter to you)? Alternatively are you happy to take a trade on a breakout to a new high? If you get into profit what trailing stop or target will you use for exiting the trades? I've probably left something out but what I'm trying to say is imo money risk management is what makes you profitable or not. The next stage is working out your £ risk exposure if the market tanks overnight. How much would you lose if everything hit its stop? Can you afford to lose that amount? After that, different risks take over once you are in profit territory but you still need to ask the same questions. Imo its worth answering all those questions and probably more so that you come up with a consistent strategy that works for you all the time, then tweak it as time goes by.
- Know the conditions under which you will exit a CFD trade before you get in. If adopt this rule, you can work out what a losing trade will cost you before you make the trade. So always have your trades worked out in advance. i.e. Entry point, exit point and stop limit. This also avoids your emotions affecting your trades. i.e. Holding onto a losing trade - Fear. Not taking a profit at your exit criteria - Greed. So do plan trades before entering and keep a log as to why you are doing the trade. This is because, psychologically it is very easy to convince yourself that you didn't have a one-day profit objective, but a five-day profit objective if the market goes against you. The log won't lie if the trading objective is written down... Do set realistic profit targets where you'll sell some or all of the position(s). If the share is rising and looking good, you can always set a second target. Also, set the stop level at a price level where you know the CFD trade will have failed. Stops should not be too far away from the buy price (say from 5% to 15%), and much less for shorter-term trades. Planning trades before entering helps to keep emotions at bay, which has wiped out many traders.
- Once you have established the entry point you now have a CFD position in the market. Two things can happen from here; the market can move in your direction making a profit in the process or the market can move against you, incurring a loss. You need a trading plan to deal with both outcomes. If the market is moving against your position, you need a to have a predefined exit point where you would bail out with a loss. This is referred to as a stop loss; a protective order placed at the time the position is opened that will automatically close your CFD trade should the market reach a certain level against your original view. For a long CFD trade the stop loss level is placed below the market. For a short CFD trade the stop loss level is placed above the market. Psychologically it can get quite stressful watching the market moving against you, however by employing a stop loss, you have already considered the downside and concluded that the risk : reward ratio is favourable.
- A sound trading plan with rules will not only help you but more importantly protect you; mostly from yourself! Placing trades without a plan makes you more prone to impulse trades when you see a moving market and this may result in positions being opened or closed prematurely. Having clear profit and loss targets can help to reduce the chances of this happening.
- Review each CFD trade when it's complete. Record what went right AND what went wrong. If you decide to change your CFD trading plan, do so on a step-by-step basis instead of all in one go = this way you are in a much better position to determine what's going well and what's not.
- Remember that you need a reasonably good edge to beat the fees in the long-run. Most people don't have that edge, but are encouraged because some other people who don't have that edge are able to beat the fees in the short-run... All of these measures will help you concentrate on formulating a strategy that SUITS YOU. Trading is a very PERSONAL thing and the best strategies are home grown, that is to say, they will evolve as you trade. Read as much as you can, but don't expect anybody else's approach to suit you. They will have different tolerances to draw downs and time in the market. If you trade too large to begin with you will become money focused. This should not be your aim. You must learn to trade for the sake of trading.
'You have to get into the nitty gritty of the product and have a good understanding of how the entry and exit rules, and risk management of your planning methodology, work together with one another,' says an analyst and trader educator at CFD provider CMC Markets, David Land. 'Your strategy needs to be able to address the appropriate number of positions, the total leverage, and the application of stop-loss methodologies.'
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