This section will discuss CFD trading tips and strategies for beginners. This article will present some simple tips that traders who are starting CFD trading for the first time can deploy to get successful results from their activity. It will also present a simple way of looking at the market, and end by presenting a simple strategy that can be used to trade CFDs.
What are CFD trading strategies ?
CFD trading strategies A set of rules guiding trade entries and exits which are meant to enable a trader to profit from a series of trades without jeopardizing the account capital. By this definition, risk management is an integral part of a trading strategy set up.
The CFD trading strategy setup we shall use today will deploy the use of chart patterns as the technical setup. The technical setup will be used to initiate trade entries and exits in the direction of the fundamentals at play within the asset.
The use of chart patterns in trading is a consequence of the cyclical nature of the markets. A tenet of technical analysis states that history tends to repeat itself. so if you see price setting up in a particular way in order to form a pattern, it is likely that the same result that was obtained previously will repeat itself.
However, trading a pattern successfully requires that you understand the price structure and you also understand the principles of price breakout/breakdown. You should also have an idea as to how to project the extent of price movements following the exit from the pattern. This enables you to take profit appropriately without having the market go against your position when such targets have been reached.
CFD Trading Strategies Using Flags and Pennants
Flags and pennants describe two variations of a similar-looking pattern, with the only distinction being that the consolidation area that follows the initial price moves forms a channel in the flag, and a triangle in the pennant. Each pattern has a bullish and bearish variety.
- Both patterns have an initial move in the direction of the trend. This is the pole.
- The initial trend move is followed by a consolidation area. This consolidation area tends to retrace against the initial trend move.
- Following the consolidation, the price moves in the direction of the initial trend to complete the pattern. The length of this completion move, from the point of exit from the pattern to the point of completion, is about the same length as the initial train move that preceded the consolidation. This makes it easier to determine the projected price point, allowing the trader to set the Take Profit target price.
The challenges with using this strategy usually change on setting appropriate entries and exit points.
Setting the Trade Entries
Before you set up the trade entries, you must first identify the initial trend move and the consolidation area. The trade entry can only be set up correctly when the trader has identified the borders of the consolidation area, as well as when the breakout move is complete. This is important because not all flag/pennant patterns setups end in a breakout.
Bull flag pattern
Look at the flag pattern above. This chart illustrated a number of things.
- The initial trend move was an uptrend. Look at the brown line trace that shows the first low, the first high, the higher low and the higher high. Higher lows + Higher highs = uptrend.
- Price went into a consolidation pattern following the initial train move. This consolidation pattern retraced against the initial uptrend move.
- Note the breakout candle. A breakout is marked by a penetration close of the price bar or candle above a price barrier by more than 1%. Some authorities use 3% as the cut-off benchmark.
- Following the breakout candle, there is usually a pullback, in which the next price candle or bar attempts to go below the price barrier that has just been breached. due to a phenomenon called role reversal (i.e. a broken resistance becomes a new support), this pullback is usually resisted allowing price to take off in the direction of the initial trend.
- The length of this breakout movie is usually the same as the length of the initial trend. Look at the chart and see this for yourself.
- The entry is usually made using a limit order, which uses the price at the price barrier as the entry price. The essence is to catch the pullback move with as few pips wasted as possible.
The stop-loss can then be set at a few pips below the price barrier that has been broken while the Take Profit target is set by projecting the number of pips that formed the initial trend in an upward direction.
This pattern has a bearish variety as well and the pennants can also be traded using the same principles.
Tips to Trading CFDs With This Strategy
- a) Obey the rules of risk management in your position sizes. Your committed capital should not exceed 3% of your total account size.
- b) Use a risk-reward ratio of 1:3 for each trade. What this means is that you should target to make three pips for every one pip you use as stop loss. This ensures that once you win a trade, you will need 3 losing trades to cancel out the winner (assuming you use the same number of pips for the stop loss and take profit in every trade).
- c) Once your trade has moved into some significant profit (i.e. 1.5 times the stop loss), move your stop loss to the trade entry price. This cuts your risk completely while allowing your profitable trade to run. The best way to deploy this strategy is to use what is known as a trailing stop. The trailing stop allows you to chase advancing prices, but remains static if price moves against you. Some traders will close half the position in profit, then set a trailing stop at the entry price (i.e. at break-even point).