How is it that one individual is consistently making money on CFD trades while another person, no less smart, hits and misses? We are all human and subject to the same foibles, so getting better often comes down to overcoming certain very human mistakes. To paraphrase Warren Buffett, though, you don’t need to make these yourself in order to learn from other people’s unfortunate examples.
Starting to win at trading CFDs is not necessarily a matter of learning more math or trying a new investment theory. Profitable trading strategies frequently amount to common sense. The difference between applying them successfully, or not, normally amounts to actually following them correctly, which may require you to review the attitude you bring to trading.
More often than you’d think, success depends not on being exceptional but on avoiding common errors. Listing them all will probably require a whole book; still, these seven mistakes turn up time and time again – especially when looking at novices to the world of CFD trading.
One: Not having a plan
When you first begin to play with CFDs, the whole process is exhilarating. You’re probably flying by the seat of your pants, trying new things every day, causing your account balance to see-saw dramatically.
However, trading is not meant to be entertaining; it is a way to make money. Experimenting with paper trading is fine while you’re a novice. Before risking serious money, though, you need to invest some time in understanding how financial markets work. Before long, you’ll also want to learn about topics like technical analysis and trading psychology – in practice, all of these work hand in hand. You’ll encounter several different trading strategies and figure out how each of them applies to CFD trading. In time, you will even figure out a trading plan adapted to your circumstances and investor personality.
This plan can be as elaborate as you wish. It’s probably best to start with the basics, though; you will certainly refine it later. For now, jot down the following on your office whiteboard or other convenient location:
- Which markets you will trade
- What time of day to trade
- How long you will hold the trades
- How much to risk per trade
- A list of your best trading setups
Two: Not following the plan
Some traditional words of wisdom go: “plan the trade and trade the plan”. The most solid and well-thought-out trading plan only helps you if you pay attention to it. For one thing, consistently making the same kinds of trades in the same situations will help you figure out if the plan does indeed work or not – it will not make a profit on every single trade, of course, but it should succeed more often than not.
Traders who make millions by simply following their gut feelings exist only in movies. By reviewing trades that were all made according to the same basic recipe, you can gauge your level of success beyond a basic P/L statement and make refinements where necessary. It’s the only way to really pursue long-term success. You may also find that a trading plan that works in one market isn’t suitable for another – forex and indices, for example, are very different.
We mentioned putting the basics of your plan on your office whiteboard, where you’re sure to see it every day. It’s also a good idea to create a checklist that spells out the trading rules you’ve set for yourself (perhaps as a spreadsheet to facilitate calculations). Work through this before every trade; if you deviate from your plan, you should have a very good, articulable reason for doing so.
Three: Overtrading
Overtrading means trading too much. At times, this can be an indication that you’re trading obsessively, impulsively, or just because you’re succumbing to the desire to “do something”.
Part of your trading plan refers to how many trades you place per week, day, or even hour. This is partly determined by your chosen markets, your trading style, and how much time you’re able to devote to market research and other tasks. Whatever your situation, there are two important considerations: whether an opportunity to make money can be confidently identified, and whether your risk management strategy allows you to take advantage of it.
Let’s say you’ve decided to trade European index futures based partly on fundamental company and economic analysis. Upcoming results from Germany are expected to be positive, so you take out a CFD on the DAX40. However, you’re confident that good news will spread to France, so you take out a position on the CAC as well. In addition, despite having little experience in forex trading and knowing that currency pairs are affected by factors other than economic performance, you also buy a CFD on the EUR/USD. Perhaps, you whisper “this time will be different” to yourself while doing so.
This is an example of overtrading, especially when you risk more than you can afford at one time or make a habit of it. Somewhat surprisingly, it’s often caused by mere boredom. Apart from sticking to your trading plan religiously, it’s important to understand how your own psychology affects your decisions.
Four: Not using a stop loss
If you make profits on some trades that are immediately wiped out by losses on others, you’re not gaining any ground. This is easy to understand, yet people still refuse to minimise their downside by using stop-loss orders.
It’s said that good investors ride their winners by cutting their losses, maximising their upside over the long term, while amateurs do the opposite. Your trading plan, as reflected in how you execute each trade, should also include some guidance on where to place stop losses. Exiting a trade at a loss may hurt, but it’s still better than waiting for your position to deteriorate even further!
Short of possessing insider information, no trade is ever certain. Thinking that you have a sure thing should set off instant alarm bells and perhaps cause you to re-evaluate what you think you know. Hedging is always a good idea, but may not be enough. The unexpected happening is always a possibility, so it just makes sense to protect your capital with stop-loss orders as a matter of routine.
Five: Overleveraging
Trading on a too-large margin is not something that only happens with CFDs. In fact, it’s not even only retail traders are prone to. Professionally-managed, apparently safe (by the standards of hedge funds, anyway) companies like Long Term Capital Management and Archegos Capital were sunk by excessive leverage combined with margin calls, in 1998 and 2021 respectively.
Both of these case studies make for interesting reading. LTCM was almost certainly overexposed at about 30-to-1, but it wasn’t until an unexpected event (Russian debt default) that the weakness of their position was exposed. Archegos’s leverage ratio was downright conservative at an estimated 5-to-1, but was exacerbated by a lack of diversification.
It may not seem like cautionary tales involving billions have much to do with you and I, but the same principles apply. Most brokerages and online trading platforms are eager to offer leverage to their CFD clients. Depending on the underlying asset class, the proportion may range from perhaps 2-to-1 (eg. crypto) to 30-to-1 (eg. major forex pairs). The ease of trading on margin should not, however, be thought of as an indication that it’s a good idea.
The amount of leverage available on your account is only one factor to consider, though. Using a combination of responsible position sizing and stop losses, you can limit your possible loss on any given trade to an acceptable level, perhaps 1% to 5% of your total account balance. If losses do occur, your leverage rate will not matter as far as the total amount of money you lose.
Six: Revenge trading
“Revenge trading” is a kind of mental bias that is often seen after a period of losses. One explanation for it is that we believe in Lady Luck as a real concept and insist that our luck somehow has to turn. Another is that we somehow feel like placing a big trade amounts ot striking a blow against the market that has hurt us. In either case, though, reality does not seem to care about our delusions.
Casino gamblers, too, sometimes become obsessed with winning back what chance and poor judgment apparently stole from them. This, naturally, leads to even worse judgment and appreciation of risk, and therefore results in even greater losses. Traders are not, sadly, immune to this kind of warped thinking.
Some good strategies to avoid falling into this trap is to either force yourself to step away from the computer after a set number of losses, or halve the amount you’re willing to invest in any given trade. In the end, though, the answer rests on self-discipline, which is indeed a trait that can be exercised and developed.
Seven: Complacency
In a sense, the reverse occurs after a series of profitable trades; it can be equally harmful and even result in the same kind of errors. When we forget the role of chance, a winning streak can make us think that we’re smarter and better informed than is really the case.
This is certainly a tempting illusion, but can easily devolve into overconfidence. In that case, we may place trades we haven’t properly researched or evaluated, or risk excessive amounts of money on uncertain positions.
How does one avoid becoming a victim to complacency? The same techniques as used to combat revenge trading apply, and basically amount to sticking to your trading plan even when it seems like the good times are a’rolling. Consider taking an hour or a day off after having a good run in order to regain your perspective. Either leave work or your home office completely, or analyse your recent trades to determine whether your success was due to a new tactic or blind luck.
CFDs mistakes in summary
Without belief in their judgment and knowledge, no trader will be able to thrive. It’s important to remain humble at the same time, though: none of us knows everything that might be going on.Due to the extensive use of leverage in CFD trading and the generally fast pace involved, losing your equilibrium and making poorly planned-out trades is a distinct possibility. You may not even realise what’s happening until it’s too late. The good news, however, is that the above patterns can be discerned. Along with a little knowledge of trading psychology, it’s certainly possible to improve your performance by avoiding common mistakes.
