The advantages of Contract for Difference trading in a volatile market
Mention the word volatile and you might get some looks of apprehension from traders. After all, the uncertainty of a fast-moving market would make someone think twice about making a trade.
In truth, a volatile market presents ripe opportunities and is something you should take advantage of.
Knowing the volatile market
First, you’ll need to understand what a volatile market means. Simply put, the market (and its associated assets) will rise and fall and the uncertainty of this is a measure of the volatility in the market. In the case of stock prices, for example, you might see the price hitting an all-time high but in the same day, drop to a level that’s totally unexpected.
Can you identify a volatile market even before you jump into it? Fortunately, you can refer to the Chicago Board Options Exchange’s (CBOE) Volatility Index, or more commonly known to traders as VIX to follow market volatility.
The concept is simple. The VIX measures and tracks the prices of options on the S&P 500 Index over 30 days. To be precise, it looks at investors’ sentiment towards the market and their willingness to raise their budget for options on the S&P 500 Index. A high VIX would indicate a highly volatile market, usually associated by a rise in option prices. On the other spectrum, low option prices would trigger a low VIX ranking.
To have a better understanding of what the VIX entails, you can download and read this free ebook written by Bloomberg that explores the workings of a volatile market.
Working the volatility angle
Buying an asset during periods of volatility has as much opportunity as risks. Should your assets swing upwards, you can see a profit on the capital that you’ve invested in. On the contrary, if the asset goes south, you would not expect the same pretty sight.
In a volatile market, price changes tend to be bigger and happen more frequently as compared to a period with less volatility. But such fluctuations can present golden opportunities for investors to profit from, regardless if you are going long or short.
In the former case, going long is banking on the expectation that an asset will perform better than your buying price. Alternatively, if you anticipate a decrease in value of the asset, going short means you are trading for profit when the asset closes at the expected lower value.
Consider this - a volatile market moves in a wider range of ups and downs. That also means you are looking at unprecedented gains for movement in any direction, but of course, you have to take proper risk management towards your positions.
How does Contract for Difference factor into the volatile market
While fortune favours the bold, it’s also important to be prudent. As it is, a volatile market can swing in unexpected ways. Rather than committing a huge capital outlay towards an asset in a jittery market, derivative trades such as Contract for Difference (CFD) is useful to mitigate losses during volatile markets.
For one, trading a CFD means you are looking at the exchange in difference of the opening and closing price of the trade. With a volatile market, the potential spread is higher, which may translate to a better profit margin or vice versa.
Secondly, you are trading on leverage with CFD. This would mean that you are paying a portion of the full value of the trade, and your capital outlay is relatively lower for a similar exposure. This capital, known as your margin, is typically a percentage of the full value of the trade.
Let’s say you are interested to open a position on Google’s parent company, Alphabet Inc. which stands at more than US$1,000. With a CFD, you can get exposure to 100 shares, for the same price of US$1,000 per share at a 5% margin. The cost for that? US$5,000 if you were using CFD, compared to the full $100,000 for a direct trade.
CFD can give you amplified gains with a lower capital outlay if the position moves in your favour but it can also give you multifold losses if your position moves against you. If it’s the latter, the low capital outlay won’t hit your bottom-line as hard as it would have been for an actual trade.
Interested to try out CFD but not fully confident? You can get more insights from industry practitioners at IG’s upcoming seminar, Make the most of volatility.
Through this seminar, you will be able to understand the potential behind market volatility and how you can spot such opportunities.
Oh, did we mention that it’s free? So you’ve got to act fast to get a slot before it’s all taken up.
Date and time: Saturday, 21 July
Time: 9:30am to 12:30pm (Registration starts at 9am)
Location: STI Auditorium, Level 9, Capital Tower, 168 Robinson Road, Singapore 068912
After that, you can test out these insights for yourself with an IG demo account.
CFD can be a failsafe for a volatile market
As the volatile term implies, there’s no telling how the market will act in times of uncertainty. In the case of CFDs, it can help to counter the uncertainty, offering various measures to keep your portfolio in check by mitigating losses.
For example, you might be going long for an asset that had been performing steadily for the past few years. Market direction, however, can switch instantly, and your best bet is to monitor the VIX for signals of a volatile market. Once that happens, hedging your portfolio in the opposite direction with a CFD can counter the unexpected movement.
The main benefits?
First, your capital outlay is significantly lower with the opposite trade since you’re trading on CFD. This means you are not taking a huge chunk of your investment portfolio to counter the downward move.
Secondly, should there be a downward move, the amplified gains from a lower selling price at closing will cover your loss for the long portfolio.
Another aspect to consider with CFD in a volatile market is using a guaranteed stop loss order for your trade. Guaranteed, as you might have surmised, is an assured move to close your position once it reaches the specified level. These guaranteed stop loss orders come with a fee, which is only payable if it is triggered.
All things considered, having a guaranteed stop loss order during volatile times can help to ensure your profits are assured, or mitigate your losses before the closing price moves further than your expected position.
Volatility equates to opportunities
At the end of the day, a volatile market presents opportunities, if you use the right tools for your trades. CFDs, with its low-cost entry and flexibility, fares well in such an ever-changing market.
The fact is, markets often experience periods of volatility. It’s crucial that you understand how to identify and make it work in your favour. For that, you can refer to the free ebook by IG and Bloomberg as a primer to a volatile market and how to navigate in times of uncertainty.
This article was sponsored by IG, the world’s No.1 CFD provider (by revenue excluding FX, 2018). All views, opinions and recommendations expressed in the article are the independent opinion of GoBear and do not in any way reflect the views, opinions, endorsements or recommendations, of IG Asia Pte Ltd (Co. Reg. No. 20051002K) (“IG”). Information is for educational purposes only and does not constitute any form of investment advice nor an offer or solicitation to invest in any financial instrument. No responsibility is accepted by IG for any loss or damage arising in any way (including due to negligence) from anyone acting or refraining from acting as a result of this information or material.