Being OTC (over-the-counter) products, there can be quite a number of differences in the specifications of contracts available as CFDs. If you are trading these financial products, you are responsible for knowing what these specifications are.
So, suppose you’ve done some trading, but a friend tells you that the market you’re in will never make your fortune, and you should be trading XXX. Perhaps he is a good friend, who is well-meaning, and you’d like to take his advice, but you’re concerned whether you can transfer your trading skills to a different type of financial instrument. Is this something you should try to do?
The answer depends to some extent on what sort of trading education you have received so far. Some skills are universal, for instance technical analysis can be applied to all markets in its basic form, even though there are some market specific aspects. As an example, you may be used to using volume for confirmation when you see a price pattern, and if you are considering trading Forex, it may be very difficult to determine any meaningful volumes.
Secondly, it is your responsibility to understand the market specifications. For instance, to start off what does one CFD of this financial instrument represent? On what physical underlying is it based? [share, future, option..etc?]. Is there an expiration date and what happens if your position is still running on expiry? What are the normal trading hours? What currency is it based on?
In relation to the quoted currency that the instrument is priced in, have you examined the impact that movement in the Dollar could have on your Sterling (assuming you are a UK resident) holdings for instance? Do you have a currency hedge in place to eliminate this unwanted exposure and remove the currency risk? For example, if the Sterling strengthens against the currency of the country where you have invested in, any profits you might accumulate in that foreign position will be reduced. Even more serious than this, if you have suffered a loss on your foreign holding, a weakening Sterling will amplify this loss further.
Your main concern should be the degree of risk that you are used to and that it does not get any worse with the new instrument. One of the main factors is the amount of leverage that each financial security has. Derivatives, including futures and CFDs, allow you to control a greater value than the amount of money you put in and this allows you to profit more when you are on the winning side, but opens you up to greater losses, requiring you to stay alert.
Just because the leverage is there, doesn’t mean that you have to use it all if you’re not comfortable with it, and this is a mistake that many newcomers make. You can limit your potential losses by being careful when you select how large a trade to make. There is no need to risk your whole account all the time, though some beginners think that they are not working at it if they do not have all of their money in the market all the time. This is a big mistake, because if the setup for successful trade is not there, you cannot generate it by putting money in.
But with all trading you should consider the most that you can lose, and adjust the amount accordingly. If you’re not familiar with the financial instruments you wish to trade, then the answer is to become informed, read the website and the information offered, and ask the friends who recommended it. When you have lost a chunk of money because you didn’t completely understand what you were trading, it is too late to do that preliminary work, and it will be your own fault. At the very least you need to understand the mechanics of placing a trade and liquidating a position, and the consequences of any movement in the underlying price.
By far, most traders prefer to invest in shares listed locally as they are more comfortable trading something they are familiar with. After all, how well do you really know the market conditions in Asia or Germany for instance? How informed are you about the local restrictions and regulations of those overseas markets? Is it really convenient or practical for you to sit up after a day’s work at the office to trade a share that is listed on an exchange on the other side of the world?
Conclusion
In some cases, it might be best to stick to CFDs based on markets that you are familiar with rather than attempting to trade markets you don’t fully understand. Sure, it can be exciting and interesting to try your hand at trading something that you haven’t ever traded before, but if you use ‘scared money’ because you’re frightened that you don’t completely understand the financial instrument at hand, it’s unlikely that you’ll make good trades, and that may actually work against you.
