If you come from a traditional trading background and are thinking about trading CFDs, then position trading is probably not the first thing that comes to mind. Conventional wisdom is that CFDs, with their margin requirements and interest payments, shouldn’t be used for long-term investments. But if you’re careful with your trades, you may find that contracts for difference work well in this context. CFDs being leveraged transactions means that you not have to tie up as much capital as you would if investing directly in shares.
But firstly, let’s define what is meant by position trading. Some people get confused at the mention of position, and go on to believe that position trading is about changing your position size in a trade, or some other aspect of position sizing. Position sizing is very important, and must be done in the context of expected risk/reward and the size of your account. Position trading, on the other hand, is defined as a long-term style of trading where your position in a trade can be held from several days to many months.
Most long-term investors could relate to position trading, which embraces buy and hold philosophies, but the idea of trading engenders the thought that there is more attention paid to where your money is at work, and to changing the trade if it is not performing to expectations. This is exactly the attitude that you should have if you are considering position trading with CFDs.
This style of CFD trading relies on long-term analysis of a share to determine the market’s probable direction. So in a sense position trading, with whatever type of financial instrument, is based on identifying long-term trends and taking a position disregarding any short-term market fluctuations in the hope of making a significant gain over a longer period unless this hits a stop loss. Depending on the underlying security, this might involve some fundamental analysis as well (especially checking to see if corporate updates are due) as using technical analysis to determine the entry and exit points. Once you have identified a strong and steady trend, it is a simple matter to use CFDs to take a long or short position in the direction of the trend, and to enjoy the gearing of your investment that CFDs provide.
One reason given for not using CFDs in long-term trading is that they are a margined product, and hence have interest charged for the length of time you hold the investment. However, being aware of this and incorporating it into your trading plan can still lead you to a profitable outcome. Even though you are paying daily interest while you hold the position, if you invest in a strongly trending stock the increase in value will more than counter that interest payment.
The other factor in favor of a CFD is that it is leveraged, therefore your initial investment is less, or you can profit from a greater holding. Typically, you may place only 10% as an initial margin, whereas if you were to buy the stocks your broker would demand 50% margin.
Of course, the picture gets much better if you can identify a strongly downtrending financial asset or cyclical stocks. In this case, when you trade a contract for difference on the short side you are paid interest daily. The interest paid is not a great deal, but going short with a CFD immediately disposes of the argument that it is too expensive in interest to take long-term trades with CFDs.
You could also combine two position trades into a pairs trade. Pairs trading relies on choosing two closely correlated stocks that are closely related to each other and which historically tend to move in tandem. Here you are looking at shares whose performance has diverged away meaning there is an inefficiency created and an opportunity to profit. The main benefit of pair trading is that your exposure to market and sector risk is significantly reduced by holding both long and short positions in equal amounts. This is because the relationship between two correlated shares is much more predictable & reliable than the outright prediction of the direction of a particular stock.
One thing to keep in mind with longer-term position trades is that such positions need stops to be set further away so as to avoid being closed out prematurely by the normal market noise. This may require you to trade in smaller position sizes (than for holding shorter term positions) so as to keep the overall risk unchanged which shouldn’t necessarily affect your returns since with position trading you are looking to trade bigger movements. So to conclude CFDs are worth a second look for your long-term goals as well as for short-term trading.