Whenever contracts for difference (CFDs) are discussed the question of whether they are only suitable for short-term trading is bound to come up. Common wisdom has it that CFDs should not be used if you are intending to hold a position in the markets for a very long time. This is because interest is charged on the amount of the contract if you take a long position. Interest will mount up if you hold CFDs as investments rather than just as trading instruments.
On the face of it, this would seem to make sense. If you want to invest your money for the long-term, you would prefer to buy something which doesn’t need a continual maintenance charge. However, just as landlords buy rental properties and apartments that have a regular cost or maintenance fee, you can figure this expense into your profit calculation and still make it worthwhile.
There are two points to be made here. The interest rate charged is usually two or three points over a base rate, so you will be paying perhaps up to 9% per year, and this is charged on the total value. On the other hand, if you have a bearish outlook, and go short with the CFD you will be paid interest at a rate of perhaps 3%. This may not be enough to make you decide on a pessimistic view of the underlying security, but if this is your conviction and the trend, then there is no reason for you not to hold the CFD for a long time.
In practice, CFDs are a powerful and flexible tool whatever your trading strategy.
The second point is that a CFD is a leveraged product, so if you take a long position and your research and instinct is correct you can profit handsomely compared with your initial outlay. With only 10% of the value of the underlying security to pay to open the position, if the value goes up a mere 1% per month, which on a trending stock would be minimal, that would be 12% per year (ignoring compounding) which would more than pay for the interest. You would gain 3% of the value of the underlying security after interest, and with an initial investment of 10% you would have made 30% profit in the year, which is not to be sniffed at.
Active traders will usually look for shorter or medium-term opportunities that last anything from a few days up to a week or two. Of course, trading CFDs in the short term is also a great way of making money, and you don’t have to get involved with calculating the profit you need to offset the interest charges. Short-term traders will naturally give more importance to technical analysis as opposed to fundamentals as in most cases this will be the overriding factor that will decide a market’s direction in the short-term. Contracts for difference will always be good for short term trading, especially when you consider their flexibility and the host of different markets and underlying securities that are available from just one CFD broker.
But just because you are used to seeing them in a short term context, that does not mean that they should be overlooked when you are considering long-term objectives especially now when interest rates are low which makes it cheap to hold CFDs for a prolonged period. As you can see from the simple example above, there is no reason to rule out CFDs for the long-term as long as you consider your costs and pay back. Of course short-term and longer-term traders have different trading methodologies. A longer-term forex trader is more likely to look for a trend and ride it for as long a possible while a shorter-term trader might be more interested in spotting repeatable patterns.
Don’t Day Trade if you can’t Make Money Trading Longer Term
A bit of advice that I’ve seen, and managed to confirm myself unfortunately, is that if you can’t make money on longer term trading, day trading is just a quicker way to lose money. I don’t day trade now, I can’t stand the thought of sitting at a monitor all day handing my money to a broker in commissions and spreads. I also need thinking time and I get caught up in the excitement of day trading and do things that I have trouble understanding or justifying later…so I simply don’t do it now.
I also think everything depends on timeframes. The more long term you think, the longer the “good periods” and “bad periods” will last – a truly long term investor can think in terms of “bad years” and “good years” while holding an index or stock. Medium term investors might look at their performance and say “good month” or “bad month”. Day traders might have a good five minutes, a bad five minutes, or a good half an hour. All are perfectly acceptable ways of doing things, you can mix all three if you feel comfortable doing so.
The effect of a pullback on buy and hold can be severe but this is the price you pay for trying to capture long term moves. I think the only remedy for the lousy feeling we get during these periods is to either look at the screen less, or learn to accept/enjoy the duller months by placing short term trades, or hedging yourself in the good times.
My conclusion is that like for like screen time, risk:reward and trading capital, stock trading is more profitable in bull markets and day trading is more profitable in bear markets because markets fall much faster than they rise. Having said that, everyone has different circumstances so it’s hard to say what’s best for each person =)
In any case good luck with your trading, it can work but it needs perseverance and good records so you can see where you went wrong.