The growth of CFDs and their practical uses have seen the contracts become important and significant investment tools. But knowing how to get the greatest return from CFDs requires an examination of some of the more prevalent investment strategies. One very popular strategy is pairs trading, where you look at two stocks in often a similar sector, perhaps Barclays and Lloyds or Tesco v Sainsbury. The investor identifies which they think is the market outperformer and market under-performer, go long on the outperformer to profit from a continued divergence between the two. People also occasionally try and pair trade between stocks listed in different countries, Nokia in Finland against Nokia traded in New York, for example.
Another notable investment strategy, is that because CFDs are a financial product it is also possible to hedge your own portfolio of stocks. If a long-term stockholder is bearish in the medium term of its prospects, they sell an equal and opposite CFD. The benefit there is, if you’re reaping a big gain on your physical stock holding you don’t have to realise that gain by selling the physical stock, and if the price does move downwards then your hedge will protect the value of your holding, because the loss you make on your physical shares will be offset by a gain on the CFD.
Although spread betting offers obvious tax advantages, the visibility and liquidity CFDs offer make them ideal for high volume short-term trades. Both institutional and retail investors are increasingly using CFDs as a vital tool within their portfolio as a complement to the long-term physical stock holding. CFDs are not, and never will be, a substitute for standard equities, but they are simply the most effective method of very short term trading, bar none.