Finding FX opportunities in today’s market while mitigating risk
Contracts for difference (CFDs), with their unique features, may help foreign exchange market traders to better trade and manage risk in volatile times.
It has been a roller-coaster ride for traders this year, with financial markets experiencing wild swings as a result of the global pandemic and the ongoing tensions between China and the United States.
From equities and fixed income to currencies and commodities, asset prices have been extremely volatile in 2020. By employing the right instruments, however, traders may be able to capitalise on trading opportunities while mitigating their risk during this uncertain period.
One asset class that presents such trading opportunities is the highly-liquid foreign exchange (FX) market, where daily trading volume far exceeds that of equities worldwide. FX markets are also open almost 24/7, giving you more opportunities to trade during the week. Furthermore, you can choose from a large range of FX pairs to trade in, including the four major ones: EUR/USD, USD/JPY, GBP/USD and USD/CHF.
TAKE LONG OR SHORT POSITIONS
Savvy traders have been seeking out potential opportunities in FX markets in the challenging environment by using derivatives products such as contracts for difference (CFDs).
A CFD is an instrument that allows traders to speculate on financial markets without having to own the underlying asset. In a CFD trade, a client and a broker both agree to exchange the price difference in the current value of an underlying asset and its value at the end of the contract.
This means that traders have the opportunity to make money regardless of whether the asset’s prices rise or fall. Being able to take a long position (when you expect the price to go up) or short position (when you expect the price to fall) on an asset is particularly useful when markets are unpredictable.
One key advantage of CFDs is the use of leverage, where you only have to deposit a fraction of the full value of trade. This deposit is known as a margin. Being able to trade on a margin means that you tie up less of your capital, which can be freed up for other investments. While leverage enables you to spread your capital further, it is important to keep in mind that your profit or loss will still be calculated on the full size of your position. That means both profits and losses can be magnified compared to your outlay, and that losses can exceed deposits.
MITIGATE YOUR RISKS
Investors should note that CFDs do come with higher risks than traditional investments. Your total profit or loss on a trade is based on the full size of your position, not the margin deposit you have placed. If a trade goes against you, the losses you suffer can be significant, and can end up being larger than your initial investment. If this happens, you may have to make further payments to make up the difference.
However, this is where risk management becomes vital, where you can put a cap on potential losses from CFDs with a feature known as stop and limit orders. These let you specify the total amount of losses you are prepared to take on for any position. This is helpful if the market turns against you unexpectedly, resulting in significant losses. A stop order will be triggered automatically at a pre-determined price.
As you are able to take short positions, CFDs can also act as a hedge for your portfolio. If you expect that a physical asset you own will fall in value, you can open a short position to offset potential losses.
A TRUSTED PLATFORM
One trusted online trading provider that specialises in CFDs is IG, an institution with a track record of more than 45 years in the trading industry. In Singapore, IG is regulated by the Monetary Authority of Singapore, and has been supporting traders here since 2005.
Using the IG platform, traders enjoy S$0 commission on FX trades, and are able to trade on extended hours for other asset classes like shares. IG clients can also explore other opportunities within the financial markets using a unique CFD product called Knock-outs, which comes with an in-built guaranteed stop, allowing traders to control the amount of risk they will take from the start of the trade. This allows them to know beforehand the maximum loss that they could potentially incur. This is especially critical during times of high volatility or when markets are closed, such as over the weekends.
For traders with the right risk appetite, trading CFDs on IG can be a way to trade FX markets smarter amid the current volatility.