The Bull

Sunday 22

April, 2018 4:55 AM



CFDs question

Is volatility a good or bad thing for trading CFDs?

Is volatility a good or bad thing for trading CFDs? Matthew Press, FP Markets

The attention of the world remains firmly focused on the US share market as volatility reigns supreme. We have seen extraordinary volatility over the past weeks as the economic outlook continues to worsen and consumer confidence remains low. As such, we have seen unprecedented fluctuations in other asset classes and instruments as Gold and Oil have had massive daily moves.

The natural result of volatility is generally a heightened sense of uneasiness for many investors and nervousness in establishing new positions or holding existing shares or derivatives.

The presence of volatility provides an ideal opportunity for many traders and investors to assess and understand what type of time frame and level of risk they are prepared to bear and refine their trading to make profitable trades or investments in markets perceived by many to be dangerous.

Importantly extreme market conditions are a positive for those looking for longevity in the markets enabling many traders to asses what type of trader they are, what works and what doesn’t work. Trending markets often forgive poor decisions, trading plans, entries or exits. In volatile conditions traders can asses their skills and develop their competencies as the markets are less forgiving.

In volatile times it is important to look and think with a long term perspective. Extreme price fluctuations occur during the economic cycle at specific times however over the long term markets will return to normalized historical levels of volatility. The 1987 stock market crash, the 91 Gulf war, September 11 attacks of 2001, hurricane Katrina in 2005 and the financial crisis of 2008 have provided severe spikes in volatility, presenting historic trading opportunities for short term and long term CFD traders. Longer term traders have been rewarded over the cycle despite periods of volatility effecting short term results.

Traders and investors use the flexibility of CFDs to position for both time periods long and short in order to better utilize capital and gain diversification to a variety of financial instruments.

CFDs have emerged as a popular volatility trading tool due to their simplicity and wide reach. Diversification from Australian equity CFDs to international markets or specific stocks has never been as accessible to retail clients as it today chiefly due to the growth of CFDs. Traders have looked to commodities during the significant price fluctuations and uncertainty, as commodities such as gold CFDs are a popular ‘a safe haven investment’ for longer term CFD traders and short term speculators.

Hedging equity positions using CFDs on global indices is a significant advantage for CFD traders. Many traders have efficiently protected their holdings from price fluctuations by taking positions using INDEX CFDs to create market neutral portfolios. These are trades that are well suited to volatile markets.

CFD day traders have embarked on strategies that are ideal for volatile markets recently; A popular approach often referred to as “scalping” has been widely used. This is an approach were a trader takes many small trades, with a low risk reward ratio attempting to consistently move in and out of fast moving instruments earning small but regular profits with limited downside. It is easy to recognize that the current market condition requires traders to implement appropriate tactics for the environment at hand. Traders have recognized that it is dangerous and destructive to use strategies based on a trending passive market to signal entries and exits.

In these conditions traders have returned to the basics of monitoring price action and volume to enter or exit trades.

Adding CFDs for leveraged exposure to equities is complemented by many ETO (exchange traded option) strategies to protect capital using put options or to generate income by selling Call options during volatile markets.

The clear measurement that the market is currently highly volatile is the record level of the VIX index. This is commonly referred to as the barometer of fear. The VIX is the calculated from index-option prices and measures the S&P 500's anticipated volatility over a coming 30-day period. It's a fear barometer because it rises when traders expect stocks to seesaw and bid up S&P options.

While volatility has the ability to provide additional trading opportunities for CFD traders it is essential for traders to maintain discipline and adhere to strict risk and money management to take advantage of the additional opportunities.

Matthew Press, Head of Sales , FP Markets


» Subscribe to TheBull's free weekly newsletter to receive all the latest news and views from Australia's leading journalists. Ask us a question

PLEASE SUPPORT OUR SPONSORS, AUSTRALIA'S LEADING BROKERS:



© Copyright The Compare Group Pty Ltd. All rights reserved.