CFDs are now one of the mostly widely traded instruments in the world, with some figures showing CFDs account for as much as a third of all trading activity around the FTSE 100 and growing. For an instrument that was, until reasonably recently, considered to be more the preserve of high-risk investors, it’s now clear that with trading volumes as they are, the appeal of CFDs has become much more widespread. CFDs are traded by traders of all shapes and sizes, from the smallest to the largest, because they deliver such massive gains over such short periods of time, and as an instrument with inherent flexibility, hard-wired into the very DNA of the CFD, they prove a useful addition to the investor’s toolkit when it comes to responding to the vastly changing circumstances of often volatile global markets.
To broadly break down those groups that trade CFDs, we’ve set out three categories in turn to analyse who trades CFDs, how they trade them in practice and the reasons why they trade with CFDs as opposed to other widely traded instruments.
The first classification of those that trade in CFDs, and the fastest growing by all accounts, is the retail investor. Retail investors are those that invest their savings for personal gain, as a pension for example, or as a means of generating a more favourable return on their capital than they would get elsewhere. Retail investors are generally the same types of people who buy into managed investment funds – those with capital to spare that are looking to deliver a return on their money. As CFDs have come to greater prominence in the financial and mainstream media, the number of retail investors in CFDs globally has shot up, and there are now countless CFD traders that fall firmly within this category of investor-type.
Retail investors tend to trade CFDs because they are lured by the substantial gains on offer. If you ask a retail investor whether they want their life savings to deliver a 10% annual yield or a 150% annual yield, there’s simply no contest. This is, of course, an overly simplistic view of the reasons for investing in CFDs, and some authorities (including the Australian Investment and Securities Commission) have expressed concern that a growing number of retail investors are being seduced by CFDs without proper acknowledgement of the risks involved.
If you come under the banner of being a retail investor, the best advice you can be given is to take it slow. Never expose your capital too readily – retail investing is a marathon rather than a sprint, and it really does pay to pace yourself over a matter of years. Aim for the long haul – even generating a 0.01% return on your capital per day is enough to make it a very worthwhile endeavour.
Speculators And Day Traders
The second class of traders engaged in CFDs trading is the speculator. Speculators and day traders, which speculate on trading activities over the course of a day or less, see CFDs as a Holy Grail of trading. High rewards across a short turnaround time means a greater return, and these guys tend to be more savvy than retail investors when it comes to understanding how markets work. Speculators tend to be more professional traders who make a living from playing the markets, and can take significant benefits in trading CFDs over other, less potent instruments.
Speculators tend to be more seduced by low transaction costs, highly leveraged trades and volatile markets, and aim to identify invariably shorter-term opportunities for profiting from the markets. With CFDs being especially suited to the short-term, because of their cost efficiency and high degree of leverage, it’s hardly surprising that CFDs have become a weapon of choice.
The third classification of those engaged in CFDs is the institutional investor. Institutional investors are organisations that are professional engaged in financial trading activities, normally because they are managing the assets of others to yield a return over time. Institutional investors tend to be more risk averse than smaller trading operations because they are accountable to their own investors – e.g. the pension holders or policyholders. Institutional investors simply cannot afford to fail, and take all steps practical to insulate themselves from risk. This means diversified trading portfolios, and a healthy balance of low, medium and high risk investment types over the short, medium and long terms.
A growing part of this kind of investment strategy in recent years has been the CFD, not only for its high leverage/high returns capability, but also for its inherent flexibility. As a means of backing winning and losing markets, and taking leveraged exposure on a cost effective basis across a diverse range of markets, CFDs slot in perfectly to the institutional investment business model, as a way of recouping losses accrued elsewhere and bolstering overall capital returns.
Determining where you fall in terms of your trading objectives, i.e. which of the first two classifications best describes your circumstances, is critical to forming an overall trading strategy, and understanding how best to proceed with your CFD trading activity. While it is tempting to rush off gung-ho into the markets blind, devising a clear trading strategy is the key to understanding how best you should approach trading decisions and the allocation of capital – vital aspects of developing a successful trading style.