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What percentage of my net worth should I hold in CFDs?


Sam Button

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Truthfully, CFDs, like most leveraged products, are not suitable for long-term investments for a number of reasons. Leverage is a trading tool, not an investment strategy, and the inherent risks and borrowing costs are a bad combination for a long-term portfolio. That said, there is definitely a place in a diversified portfolio for CFDs over the short term. Aside from using them as a defensive strategy to hedge other open positions, CFDs allow you to profit from short-term swings and smaller price movements in the market. Ideally, you should have at least two “portfolios”: Your long-term buy-and-hold investments you keep for retirement and other major savings goals, and your trading portfolio, which is money you can afford to lose. Your approach to risk is very different within the two accounts. Conventional wisdom says that you should have a percentage equal to 110 minus your age in “safe” investments with the balance in stocks in your long-term portfolio. Within this portfolio, CFDs are useful to hedge other positions. For example, if you are long with S&P 500 equities equivalent to 20% of your portfolio, you may want to hedge against a bullish market by shorting an equal value in index fund CFDs. This is a smart use of CFDs in a long-term portfolio. On the other hand, you have a lot more options with CFDs in your trading account. If you are a day trader, CFDs are ideal instruments for scalping and other intraday trading strategies. But even within your trading portfolio, diversification is a good idea. You need to balance your risk both in individual positions and within the account as a whole. For example, you should never risk more than between 1% and 2% on any single trade. If you have $50,000 in your trading account, your maximum loss on a trade should be less than $1,000. That doesn’t mean that you can only utilize 1% or 2% of your capital, but it does mean you should use stops to limit your loss. This is especially important with leveraged CFDs. You should also hold both long and short CFD positions, which is much easier to do with CFDs than with actual stocks—and you should also balance your trades across asset classes and sectors. Everyone knows instinctively that it’s bad to put all your eggs in one basket, yet too many novice traders do just that and tie up all their capital in one trade. It’s really impossible to give a pat answer to how much net worth you should have tied up in CFDs, because that figure is different for every trader. Bottom line? Whatever you risk in CFDs should be money you can afford to lose and not money you’re counting on for long-term savings goals, and your trades should be structured to limit your loss to no more than 2% of your trading capital.
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