How CFDs fit into your portfolio
After learning more about CFDs and their features, you must be wondering where these financial instruments fit in your investment portoflio. You may already have a healthy share portfolio that you want to keep on growing.
While CFDs may not be the ideal vehicle for the long term buy and hold investing approach, they definitely have a place in an investors portfolio.
Lets take a look at some of the ways you can use CFDs in your portfolio:
Cost Effective Entry to Trading
Because you only need to pay a small percentage of the total value of a transaction to open a CFD trade (we learned about using margin earlier in the module) CFDs can be a relativley cost effecient way of trading the markets.
For example, if you want to buy 1000 shares of XYZ company at $8.00 a share you will ned at least $8000 to open the trade. If you trade CFDs of XYZ company you would only need 5% of the $8000 to open the trade.
You need a substantial trading captial to get into this trade if you buy the actual share and this will limit your ability to ope other trades if you have a limited capital.
Trading CFDs means you can start with a smaller amount of trading capital.
Portfolio Diversification
Whether you are a long-term buy and hold investor, you can use CFDs to take advantage of short-term profitable moves in the market without affecting your long-term investment.
This means that while you long-term positions are growing over time, you can trade CFDs to deliver profit from short to medium-term trades.
By introducing this kind of diversification, you can maintain your share portfolio for capital gains and ongoing dividend income while also maintaining a CFD portfolio for shorter term trading whichever direction the market moves.
Trading CFDs means you can start invest as well as trade.
Portfolio Hedging
Heding means protecting or trying to minimse any risk that may affect your existng investment portfolio. We talked about the concept of hedging earlier in the module.
Many people are using CFDs as a hedge to protect against their share investments.
For example say you bought 1000 BHP shares at $28.00 expecting that the price will go higher in the months to come because of the global demand for resources. You intend to keep your BHP shares as a long-term investment. However, after a few days of buying the shares the price wnet down and it is now trading at $27.75. You still believe that BHP shares sill go higher in the medium to long-term period, but in the mean time the share prices has been going down for the past few days.
You can short sell 1000 BHP shares CFDs to hedge your share position in the short term. this is because every cent movement in the physical shares (in this case it is going down, therefore you are losing) will be matched by the same movement in the share CFD (In this case, because you have a short position you are making money if the price of the share CFD goes down) This means that the losses in the physical shares are being offset by your gains in your short CFD trade (not withstanding personal tax treatments and brokerage rates of course!)
Trading CFDs means you can minimise your risk by hedging.