Hedging With CFDs

cfdThe hedging process allows a trader to protect himself and the trades he makes, in order to prevent losses that are unexpected. He does this by using long positions combined with short positions that correspond, allowing for a profit to be made both when the market goes down and when it goes up. Another benefit of hedging is that it gives you the option to keep your investments while without it you might’ve had to give up while taking some serious losses in the process.

The CFD is one of the instruments that can be used for this purpose, to protect an existing position.

Single Shares as Hedging Strategies for CFDs

If you use this particular strategy you are combining both the CFD and the share trading, using the position of one share together with one of a CFD whenever the market proves to be volatile.

To give you a quick example, if you own 500 shares in a company that just got some bad news, you might be expecting the share price to go down, without knowing for sure that it will happen. Instead of getting rid of the position, you can hedge with the help of a CFD. You do that by going short and selling 500 CFDs at a certain price. If you’ve been proven wrong and the shares go up instead of down, you get a profit from the shares and a loss from the CFDs that you sold at a smaller price. Overall though, you don’t lose your money. If you believe that the share price will keep going up in the near future, you can choose to close those CFDs in order to be able to enjoy the profits that will come from that point forward.

If the shares drop in value instead of going up, the shares will mean a loss for you. Since you’ve used CFDs at a higher price than the new low, you have a profit to offset the loss on the shares though. You get to close the CFD once you think that the shares will not go down more than they did already.

In a situation when the share price doesn’t go either up or down, you wouldn’t make a loss or profit.

Pair Trading Used For Hedging With CFDs

The pair trading process means that you purchase a company’s CFD and at the same time you get rid of the CFD from a company that’s basically a rival (same industry). With industries usually behaving the same way, companies that are part of them will also move either up or down together. The thought is that a CFD will make a profit at all times with the other being a loss.

It often happens that a trader will purchase CFDs based on shares that are from big companies in a industry that are considered strong and at the same time they would sell a CFD from a weak company that activates in the same industry. In theory, the gains that you get from a strong company will be much better than the losses that would be incurred by weak companies. This type of hedging can be used in order to make plenty of profits in order to offset losses that might appear, plus getting a net gain.

The downside would come when the CFDs will go in different directions than you expect them to, and if that happens with both of them the result can be either a loss or a win.

Index Diversification

The third way of hedging risks that might appear in the account is to diversify the investment that is made across a spectrum that is as broad as possible. Making an investment in the stock indices can be a way of achieving that. You would be making a bet that the market in Australia or Japan will go up or down, without actually deciding on individual shares. You go short or long on those CFD positions, depending on the direction you think the market will go.

Since you can use the CFD in so many different ways, they are diverse from the get go. They can be used with stock indices, with shares, bonds, rates, options, binaries, commodities, global shares and Forex.

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