Long Term vs Short Term
Understanding how CFDs work in financial terms and how they respond to market dynamics is one thing, but it doesn’t cover a very key and often overlooked element of the CFD trading puzzle. The duration of the trade is a balancing act that takes experience and inevitable trial and error to learn, and the longer you hold on to a position the more complicated it becomes to crunch the numbers and work out if it’s a viable proposition. Deciding which over a long or short term strategy is best suited to a particular trade is something you need to judge with finesse, and only by understanding the key advantages and disadvantages of each alternative can you begin to piece together a comprehensive set of trading rules. To say CFD trading was exclusively a short-term instrument would be incorrect, but there are certainly advantages to getting rid of your CFD position sooner rather than later.
Short Term Trading Benefits
The benefits of trading CFDs short term make it primarily an instrument used for more dynamic trading. Whether you’re going long-term or short-term, the advantages of leverage remain the same, and the earnings potential is arguably greater the longer you ride out a profitable swing. However, the real distinction lies in the increasing costs of funding a CFD position over time. Essentially, a CFD position that is viewed as delivering a short-term return is a much more simplistic prospect than one which is to be held over a period of weeks. With short-term CFD positions, you only need the market to move marginally in your favour to deliver a return and bag a profit. Without ever suggesting that CFD trading is easy, a shorter-term trading outlook, while relying on a greater trading volume and research burden to deliver comparable returns, is much more straightforward to calculate and execute successfully than a more long-term position.
When you trade CFDs over the course of a day or two, your profit computation need only be concerned with looking at the raw transaction costs. How far does my position need to move to yield a profit, taking account of the costs of commission? This becomes a far easier calculation when you’re looking at a flat 0.5% charge on transaction sizes, which makes split second decision making more straightforward while also saving money on aggregate with positions that require less of a movement to deliver a return.
Long Term Trading Benefits
Conversely, for traders looking towards more long-term positions, the issue of funding leverage becomes all the more pertinent, and makes the arithmetical calculation much more difficult for on the spot decision making. Furthermore, long-term positions are expected to work harder and more consistently in order to offset the creep of financing costs into profit. A long-term position with a constant value will lose money, because the daily costs of financing will start to very quickly eat into any profits the trade has notionally realised. For this reason, it’s imperative that positions envisaged as being held over the longer-term are chosen on the basis of their longer-term earnings potential, given the need for a run of good trading days in order to maintain the value of the position.
That said, long-term trading positions have advantages of their own over shorter-term positions – namely that they can by definition deliver greater returns. If you jump on board a three-day price reversal at the right time, you can expect to be very much in the money. But this of course depends on whether you can offset the costs of financing the size of your position each night. Assuming the financing costs work out to be less than the gains made over the course of the three-day period, the benefits of an extended period of leverage will outweigh the drawbacks.
Similarly, trading long-term means trading with less volume, which helps cut down on the ongoing costs of broker commission. While this isn’t usually a significant amount on individual transactions, any switch in strategy would also need to factor in the savings from trading less frequently in calculating which was more cost effective.
In all practicality, some situations will call for a short term trading stance, whereas others will benefit from being held over for a longer period. So long as you understand how CFDs perform differently over time, you should be adequately positioned to make these kinds of calls as to how and when best to trade CFDs.
Having looked at how CFDs work in some depth, how they are priced up and how they can be traded to accommodate different market scenarios, we now turn to our final consideration in the investigation of what makes CFDs tick – the interplay of indices, markets and orders for CFD speculators.