Have you ever wondered what is the difference between being short the EURUSD and being short an index? How is it possible to short something, or to sell something, without owning the product?
This is not possible when trading the regular stock market. The strategies used there are different for the simple reason that one cannot sell something that it is not already part of a portfolio.
This raises a big question mark: what is a trader supposed to do if he/she owns a stock in a regular stock account and the analysis points for a short-term retracement? The idea of the stock trader would be to add to position to have a better average in the end.
While this is correct, there is no profit made from the move lower. The answer to this riddle is to trade CFD’s in a different trading account. Forex brokers offer plenty of cfd options for the trader to profit from.
Explaining a CFD
A CFD stands for Contract for Difference and a profit is made if the price is moving in the trader’s favor. Exactly like in the case of a currency pair, if the CFD is sold and the price is moving to the downside when the trade is closed, the positive difference represents the profit.
That is, the profit before the associated costs: commissions and other fees that come in the form of spreads, swaps, etc. Nevertheless, if these other expenses are deducted from the profit made by shorting the CFD, the trading account grows.
Exactly like in the case of the Forex market, a CFD is a financial instrument based on a financial product. Such products can be commodities (gold, oil, silver, cocoa, palladium, natural gas, iron ore, etc.), indices (Dow Jones, S&P 400, Dax, Cac40, Nasdaq, etc.), or even individual stocks!
In other words, the perfect situation in the example illustrated above would be that the trader owns a stock in a regular stocks account, and can trade a CFD denominated in the same stock. The CFD would be shorted to profit from the lower move that is expected to come, while the stock would be kept for a long-term perspective.
By the time the CFD cashes in, the trader can either add on the long side on the stocks account to have a better average or simply wait for the market to recover as the profit on the downside has already been realized by shorting the CFD associated with the stock.
While in theory is simple, is a bit more complicated, but not impossible to do. Stocks accounts are most of the time cash accounts.
This means the broker will buy that much stock as your equity shows. With CFD’s, a margin is blocked and a leverage is used.
While a leveraged product opens the gates to more returns, it is also riskier to be traded. Nevertheless, proper money management techniques may result in constant profits to be made.
The idea behind trading a CFD is to treat it like any other currency pair in a Forex trading account. It should be viewed as a tremendous opportunity offered by the Forex broker: that is, the possibility to trade different financial products on the same trading account!
Multiple trading strategies can be used in a trading account that allows CFD trading: partial hedging between correlated products, portfolio diversification, and much more. Part of any trader’s success is the ability to recognize the characteristics of the product that is traded and to profit from the differences between different products.
Only because they are all moving in the same trading account, it doesn’t mean they are the same and should be traded as such.
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