How Do You Trade CFD Effectively?

How to trade CFD

Before diving into CFD trading, the first step is to open an account with a reliable broker. You can read our article on 5 Best CFD Brokers (2024) - Top Trading Platforms to find the best platforms for CFDs.

Once you have your broker account set up, the next crucial element is selecting and applying an appropriate trading strategy.

What are the types of CFD trading strategies?

Selecting the right strategy depends on various factors, including market conditions, trader's experience, risk tolerance, and investment goals. Before you start CFD trading, understanding these different strategies is paramount. Before you risk real money using any of the strategies, make sure with a demo account that the odds are in your favour.

Five successful CFD trading strategies

Some strategies are sometimes simply better than others, and below you can find a list 5 CFD trading strategies that have historically proven successful if done right:

1. Fake freakout of the psychological level: This strategy capitalizes on the market's reaction to significant psychological price levels, which often see a false breakout before the true market direction is established

2. Breakout of consolidation pattern: Here, traders focus on identifying and acting upon breakouts from consolidation phases in the market, which often signal the start of a new trend

3. Parallel channel: This involves trading within a parallel channel, buying at the lower trend line (support) and selling at the upper trend line (resistance), effectively capitalizing on the market's range-bound movements

4. False trend reversal: This strategy is based on identifying and responding to false signals of a trend reversal, allowing traders to take advantage of continued trends or swift counter-movements

5. Dead cat bounce: Predominantly used in bearish markets, this strategy involves recognizing a temporary recovery in a declining market, which is usually followed by a continuation of the downward trend

Fake breakout of the psychological level

The "Fake Breakout of the Psychological Level" strategy involves identifying significant price levels that are widely monitored by traders, such as round numbers or historical highs and lows. These levels often hold psychological importance and can influence trading behavior.

A fake breakout occurs when the price briefly breaches these levels, triggering a response from the market, before reversing direction and returning within its previous range.

Setup to sell at false breakdown of important psychological resistance

In the provided chart example, the EUR/USD currency pair appears to make a decisive move above a round number resistance level, suggesting a breakout. However, this breakout is not sustained, and the price quickly falls back below this level, indicating a false breakout.

This creates an opportunity for traders to enter positions contrary to the breakout direction, anticipating the reversal.

Here are the steps to trade a fake breakout:

1. Identify a significant psychological level (e.g., round numbers, hundredths for currencies)

2. Wait for the price to break through the level

3. Confirm that the breakout is not supported by high volume or other confirming indicators

4. Enter a trade in the opposite direction of the breakout after the price moves back through the psychological level

5. Set stop-loss orders just beyond the level that the price initially broke through to manage risk

The table below outlines the pros and cons of this CFD trading strategy:

Understanding the market context and sentiment is vital when trading fake breakouts, as not all psychological levels will produce a tradable reversal. Combine this strategy with solid risk management to mitigate the chances of significant losses.

Breakout of consolidation pattern

This strategy identifies when the price of an asset moves out of a consolidation phase, which is characterized by the price trading within a range-bound area or pattern, such as a rectangle or a triangle. This strategy is based on the idea that when the price finally breaks out of this pattern, it can indicate the beginning of a new trend.

Start of an uptrend after a period of consolidation (accumulation)

In the provided example of the Gold Spot versus the U.S. Dollar (XAU/USD), the market is depicted as moving within a narrowing range, forming what appears to be a triangular consolidation pattern. The strategy comes into play when the price breaks out above the upper trendline of this triangle, indicating potential for a new upward trend.

To trade a breakout of a consolidation pattern:

1. Recognize a clear consolidation pattern in the price chart

2. Determine the support and resistance levels that define the consolidation range

3. Watch for a price candle that closes outside of this range, which could signal a breakout

4. Enter a trade in the direction of the breakout with volume confirmation for additional validation

5. Set a stop-loss just inside the pattern to protect against false breakouts

6. Take profit targets can be estimated based on the height of the pattern projected from the point of breakout

Parallel channel

The Parallel channel strategy involves trading within the confines of three parallel lines, which represent the support and resistance levels of a price channel. The market moves within this channel, providing clear boundaries for trading. Traders look to buy near the lower trendline, where the market finds support, and sell near the upper trendline (or median line), where the market meets resistance.

Example of how to trade on the parallel channel strategy

The EUR/USD daily chart displays a rising parallel channel with the price oscillating between the upper and lower bounds of the channel.

Until February, EUR/USD traded in the upper half of the channel. Then the channel widened downwards and the price found support near the new lower boundary. Traders could switch to the lower timeframes to find a favorable entry point for a long position in the expectation that bullish sentiment would recover.

Here are the steps for trading CFDs on the parallel channel strategy:

1. Identify a channel by connecting the highs and lows

2. Confirm the channel by ensuring the price touches each line at least twice

3. Enter a long (buy) position when the price approaches the lower trendline and shows signs of bouncing upwards

4. Enter a short (sell) position when the price reaches the upper trendline and starts to decline

5. Place a stop-loss just outside the channel to protect against breakout failures

6. Set profit targets based on the width of the channel or prior price swings within the channel

False trend reversal

This strategy involves identifying and trading on price movements that falsely signal a reversal of the prevailing trend. This can happen when the price makes a new high or low that is not supported by fundamental or other technical indicators, suggesting that the trend will continue rather than reverse.

Example of setups for selling and buying

In the provided GBP/USD chart, two scenarios are highlighted: one where a "Fake Higher High (FHH)" is formed during a downward trend, and another where a "Fake Lower Low (FLL)" occurs within an upward trend. In both cases, the price moves past the previous high or low, implying a potential reversal, but then swiftly returns to the direction of the main trend.

To trade a false trend reversal:

1. Identify a strong prevailing trend

2. Look for a new high or low that goes against the trend (FHH in a downtrend or FLL in an uptrend)

3. Confirm the falseness of the breakout. Usually, the price in such cases goes not far beyond the previous high/low and quickly returns. As if having the purpose of activating stop-losses

4. Enter a trade in the direction of the main trend after the price reverses from the new high or low

5. Place a stop-loss just beyond the new extreme to protect against a genuine reversal

6. Set profit targets based on the strength and duration of the prevailing trend

Dead cat bounce

The Dead Cat Bounce strategy refers to a short-lived recovery in the price of an asset that is in a prolonged decline, followed by a continuation of the downtrend. It is called a "dead cat bounce" because, just like a dead cat that might bounce if dropped from a height, the price jump is typically followed by a fall. Traders use this strategy to identify the temporary recovery as a selling opportunity before the downtrend resumes.

Examples of dead cat bounces

The image shows the NASDAQ 100 index on a 4-hour chart where a sharp decline is followed by a modest, brief rally, illustrating a potential 'dead cat bounce.' The price fails to sustain the rally and continues its downward trajectory. This pattern is suggestive of a bearish market sentiment that is not reversed by the short-term recovery.

Steps to trade a dead cat bounce:

1. Identify a strong downtrend in an asset's price

2. Look for a temporary rise in the price, which does not break the established downtrend pattern

3. Confirm that the bounce is likely to be temporary using technical indicators, like low volume during the recovery or resistance levels holding strong. Ideally, the top of each subsequent bounce is below the previous one

4. Enter a short position during the bounce, anticipating the continuation of the downtrend

5. Place a stop-loss slightly above the peak of the bounce to protect against the possibility that the recovery is not temporary

6. Set profit targets based on previous support levels or other technical analysis tools

Best CFD Brokers

1. RoboForex - best overall for beginner traders and experienced investors (12,000+ assets)

RoboForex Review

Open an account

Your capital is at risk.

In 2009, RoboForex Ltd. was established. RoboForex has been offering trading services on a global basis ever since it entered the market for Forex brokers. The broker specializes in trading automation solutions such as the CopyFx auto trading platform, as well as the bot builder. RoboForex supports both 12,000+ CFDs, as well as direct trading in US shares with extra low fees from 0.09 cent per share.

The account type selected on the interface at RoboForex will determine the spreads. For EUR USD, the spreads' is ranging from 0.03 to 1.4 pips for different account types. RoboForex provides 0% fee on all deposits and withdrawals.

RoboForex is generally governed by Belize's Financial Services Commission. At RoboForex, there is a civil liability insurance program in place that offers industry-leading defense against errors, fraud, omissions, negligence, and other risks that might result in losses for clients.

2. Pocket Option - best for a copy trading service (signals from MQL5.Community)

Pocket Option Review

Open an account

Your capital is at risk.

Pocketoption was launched in 2017. The broker gives its clients access to trade currency pairs, commodities, stocks, cryptocurrencies, and indices. To operate in the financial markets, the company has developed its own unique trading platform. In addition, Pocket Option clients can trade in MT5. The broker’s service is available in more than 95 countries and regions globally. Pocketoption’s top priority is the high quality of customer service, constant improvement of trading technologies, and financial innovations.

The company's clients get access to many bonus offers, and participate in a profitable affiliate program. Thanks to unique rewards, traders can increase their profile level and purchase resources in Pocket Option's own Market store to increase their profitability while trading.

Leverage is a tool that is offered by numerous brokers to traders. With leverage, traders can open larger positions, allowing them more exposure to the market in which they are trading despite their small initial deposit, and PocketOption offers a maximum leverage of 1:100 on its MT5 Forex account.

The company behind the Pocket Option website that provides brokerage services is PO Trade (SV) Ltd, which is registered in Saint Vincent and the Grenadines, considered to be a Caribbean offshore tax haven. The company says on its website that it is regulated by the International Financial Market Relations Regulation Center (IFMRRC), which is not an official regulatory authority

CFD trading strategies to avoid

Knowing what strategies to avoid is just as important as choosing which ones to employ. In CFD trading, certain strategies might seem straightforward but are often misleading and risky:

1. Crossover of moving averages: Can produce false signals due to its lagging nature

2. Crossover of zero line by MACD: Prone to giving misleading signals in volatile markets

3. Overreliance on technical indicators: No single indicator should dictate your trading decisions

4. Ignoring economic releases: Economic events can drastically affect the markets, and not accounting for them can be costly

5. Chasing performance: Entering trades after a big market move can result in losses if the trend reverses

6. Martingale strategies: Doubling down on losses can lead to significant financial damage, especially with leveraged trades

7. Impulsive news trading: Quick reactions to news without understanding its full impact can lead to poor trading decisions

It's vital to have a balanced trading plan that combines technical analysis with an understanding of market fundamentals and risk management.

CFD trading tips

Successful CFD trading hinges not just on the strategies you choose but also on how well you execute them with discipline and awareness:

• Personalize your strategy: Understand and adapt strategies to fit your risk profile and investment goals instead of copying others

• Do thorough research: Dive deep into the strategies to grasp their underlying principles

• Utilize volume analysis: Volume can validate price movements and signals

• Back-test strategies: Use historical data and a demo account to test strategies before going live

• Risk management: Only invest what you can afford to lose and manage risk through proper stop-loss orders

• Professional advice: Consult with experts, especially when you're uncertain about your trading decisions