Speculating with CFDs

Typically short-term, speculative trades are generally coupled to major market events such as central bank interest-rate decisions and company results.

Traders want to capitalize quickly through a timely entry into trades that will see prices take off on the news, and then a timely exit with their profits intact. CFDs are an ideal investment tool for speculation because they have the advantage of leverage that allows you to maximise exposure whilst minimizing investment. Using leverage allows you to increase your potential profits and losses so you should always employ stop losses and other risk-management techniques.

In this section we will describe some typically speculative opportunities and explain how to grasp them:

• Speculative Trading Opportunities
• Implementing Speculative Trades

Trading Opportunities

Speculative trading opportunities tend to have one unifying feature: their link to news announcements. Such announcements may contain the government’s latest employment figures or they may be a company’s quarterly earnings. Either way, they frequently have the potential to cause dramatic shifts in the market.

Examples of news announcements that could create speculative opportunities are:

• Breaking news
• Company reports
• Economic data
• Index additions/deletions

Breaking news announcements are unscheduled events that will influence share prices. Breaking news like a merger announcement should be beneficial to share and CFD prices, though occasionally the value of a merger is not apparent and the price adjustment will reflect any uncertainty. Negative news announcements will have an adverse affect on share prices.

Company reports provide information regarding recent company performance and plans for the future. Scheduled in advance, they give traders every chance to prepare themselves and take full advantage of their contents. Company reports are not only publications of results for the last quarter, half or year. They should also anticipate trading during the next six months and this will have an impact on the share price. Traders need to digest this information and form opinions on it. When a company’s report shows it performs well and will continue to do so, its prices tend to move higher. Of course, the converse is equally true. Poor and pessimistic reports have a negative affect on share prices.

Economic data emerges in news releases commonly scheduled months in advance, offering traders the opportunity to consider the evidence, predict the announcement and capitalise on the market movements that they feel will happen. Economic data includes inflation, gross domestic product (GDP) information, interest rate announcements and unemployment figures, all of which tend to influence broad markets rather than individual companies. It therefore makes sense to utilise index-based CFDs when speculating on these announcements. When economic data indicates that the economy is buoyant, share prices tend to move higher. If that data is poor, however, prices will usually fall.

Index additions/deletions occur when major market-tracking companies such as Standard & Poor’s adjust the composition of their indices. This might happen, for example, if a company can no longer meet market-capitalization requirements and is therefore de-listed from the S&P 500 index.

Index additions and deletions usually occur at prearranged times though the identity of the individual shares involved is not divulged until the announcement is made. Traders may well realise which shares are likely to be affected, but it will not be confirmed until the announcement. Being added to an index typically raises a share’s demand and its price. It will of course then be required as a component of index-tracking funds. Conversely when shares are de-listed the index-tracking funds sell the share, and its price typically falls.

The Expected Is Already Priced In

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An important point for speculative traders to remember about opportunities precipitated around news announcements is that expected movements are already priced into the share price.

Investment analysts, economists and other market participants analyze anticipated news announcements, trying to second-guess the consequences of the news on pricing. Whilst they are unlikely to entirely agree on anything, they do generate a consensus that is useful. This consensus, containing the average estimate, allows traders to capitalize on price movements once the news announcement is released. This is because the average estimate will already be “priced into” the value of the share. We will explain how this occurs.

After their analysis, traders take advantage of anticipated movements. Rather than wait for the announcement they pre-empt the market. So, by the time an announcement is released, most traders have already taken a position.
When news announcements accord with average estimates, prices barely move. This is because the majority of traders have placed their trades. Yet, when news announcements differ from the average estimate, prices must adjust – either up or down – to accommodate the economic reality. This adjustment creates opportunities for the traders.

Implimentation

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Implementing Speculative Trades

Identifying news announcement or other stimuli that should cause prices to move will then provide opportunities to capitalise on price movements in three ways:

• You can enter your trade immediately after the announcement
• You can let the market digest the announcement, then act on it and establish a trend, before you enter your trade
• You can set two entry orders, one above the CFD’s current price and one below it, just prior to the announcement

Entering Immediately Following a News Announcement

Entering trades immediately after an announcement can be difficult because prices tend to adjust sharply when investors have incorrectly guessed the news. So to do this you must get the news quickly, evaluate it quickly and then enter your trade order quickly. Moreover, you need to do this before the price has already taken off. And it will do that quickly too. Traders jumping into trades after the announcement will usually pay a higher share price or sell for a lower price.

Entering Once a New Trend is Established

Most CFD traders who trade on news choose to wait until new trends are established. This is typically the easiest way to capitalise on it, because initially the CFD price will fluctuate as investors speculate on how the underlying asset will trend. Once this fluctuation has abated, it is a good time to participate, but traders who work this way need to learn to ignore the superfluous ‘noise’ before a clear and enduring trend settles. Doing so gives them an advantage over other traders, those who enter too quickly and are caught out by early reversals and prices that trigger their stop-losses.

The direction in which a CFD is going to move is usually clear within 2 to 5 minutes of the news announcement that sparks its movement. Those few minutes will be ample time to shake out any investors trying to buck the trend so it makes sense to use short-term charts – ideally 1 or 2 minute charts to monitor price movements after announcements.

Using Entry Orders Before the News Announcement

Placing entry orders prior to announcements is the most profitable way to trade the news – assuming that you are correct and that the price moves in the preferred direction. By placing orders before the price moves you have the advantage of entering the trade at the price you want. There are risks with entering trades before the news announcement because the market can fluctuate significantly in the aftermath of announcements and will take a little time to settle down. Ultimately the majority of participants perceive the news to be bullish or bearish then act accordingly. In the meantime, you could be knocked into the trade once your entry order is hit, then knocked right back out of it once the price turns around and hits your second entry order.