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Tame volatility with CFDs

Contract for differences instruments offer investors many advantages when trading in volatile markets

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A staff member at CMC Markets headquarters in London.

Financial markets have been on a wild ride in 2020 as the Covid-19 outbreak wreaks havoc on economies and businesses around the world. In equity markets, stocks climbed to all-time highs earlier in the year, only to plunge to two-year lows in a matter of weeks, before recovering rapidly over the next month.

This extreme volatility has forced many investors on to the side lines, holding onto cash as they ponder their next move in a highly uncertain market. While Wall Street’s CBOE Volatility Index (VIX), also known as the fear gauge, has fallen since hitting record levels in March, it remains at higher than normal levels. VIX Futures also point to expectations for heightened volatility for the rest of the year. It’s a similar situation in other asset classes.

Profiting from volatility

Despite the uncertainty, savvy investors can profit from trading opportunities that emerge during times of volatility, if they employ the right instruments and strategies. For instance, traders are using derivatives products such as contract for differences (CFDs) to profit from the rising or falling of prices of an asset. 

A CFD is a tradable contract between a client and a broker who agrees to exchange the price difference in the current value of an underlying asset and its value at the end of the contract. It allows investors to profit from price movements of an asset without having to own the underlying asset.

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Know the risks

However, it’s important to note that CFDs do carry higher risks than traditional investments, as prices can move rapidly against you. As such, it's possible to lose more than your initial investment, and you may be required to make further payments. Therefore, CFD trading may not be appropriate for everyone.

For investors with the appropriate risk appetites, however, here are some advantages of trading CFDs in a volatile market environment.

Trade more efficiently using a margin

CFDs allow you to trade on a margin, or on leverage, which means you only need to put down a fraction of the full value of a position; freeing up your capital for other uses. As a generic example, if you were to buy the equivalent of 10,000 telecom company share CFDs with CMC Markets, you would only need to deposit 10 per cent of the total value of the position. You would have to pay 100 per cent of the position value if you had bought the physical shares from a stock broker.

As such, if each share cost $1.50, then you would only need to deposit $1,500 with CMC Markets (10 per cent of $15,000 = $1,500) plus a commission, which in this instance would be $10. 

While trading using margin means you can significantly enhance the returns on your investment, do note that the losses will also be magnified if the trade does not go your way. This could result in you losing more than your initial margin deposit. Thankfully, there are tools you can employ to mitigate such risks (see next point).

Mitigate risks with stop loss orders

CFD traders employ an instrument known as guaranteed stop loss orders (GSLOs) to put a limit on the losses they are prepared to take on a position. CMC's trading platform allows investors to place a stop loss order when they open a new position.

For a small premium, GSLOs gives you the peace of mind that you will not be caught unexpectedly with large losses if the market turns suddenly; something that is likely to occur in today’s volatile environment. Instead, the stop loss will be executed at a price determined by you, regardless of what the market is doing. GSLOs are also triggered automatically, which means that you do not have to constantly monitor your positions.

Make money even when markets are falling

CFDs offer traders the ability to take a long or a short position on an underlying asset. This means that you can bet on the value of an underlying asset falling in value in a down trending market, giving you more options for making money in an uncertain environment.

Being able to take short positions also enables you to use CFDs as a hedge for your investment portfolio. For example, you can take a short position in a CFD of an underlying asset that you physically own if believe that the asset will decline in value in the short term. The ability to hedge is especially critical when markets are volatile.

Gain access to multiple asset classes

From equities and indices to commodities and FX, investors can use CFDs to gain exposure to a broad range of asset classes; allowing them to capture opportunities wherever they emerge across the investing landscape.

Furthermore, some trading platforms offer 24-hour trading, giving investors an additional edge in fast-moving markets. For instance, with CMC’s Next Generation trading platform, you can place CFD trades on currencies, indices, commodities, shares and treasuries and access over 9,000 different instruments.

How do CFDs work?

When you trade CFDs, you don’t buy or sell the underlying asset such as shares, currencies or commodities. Rather, you buy or sell a number of units of a particular asset depending on whether you think prices will go up or down. 

CMC offers a wide range of CFD instruments, including shares, treasuries, currency pairs, commodities and stock indices, such as the Singapore Free. For every point the price of the instrument moves in your favour, you gain multiples of the number of units you have bought or sold. For every point the price moves against you, you will make a loss. CFDs can be traded on leverage, which means that traders need to put up only portion of the total value of a trade to open a position.

CMC Markets was established in 1989 and is now one of the world's leading online financial trading businesses. The company serves retail and institutional clients through regulated offices and branches in 13 countries, with a significant presence in the UK, Australia, Germany and Singapore. CMC Markets offers an award-winning, online and mobile trading platform, enabling clients to trade thousands of financial instruments across forex, indices, commodities, shares and treasuries through contracts for difference ("CFDs"). More information is available at http://www.cmcmarkets.com/en-sg/. 

This advertisement is for information only, not an investment recommendation or financial advice. Losses can exceed your initial deposit. See risk warning/disclosure & other important information on our website: www.cmcmarkets.com.sg. This advertisement has not been reviewed by the Monetary Authority of Singapore (MAS). CMC Markets is regulated by MAS. 

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