The desire to trade Contracts for Difference (CFDs) often stems from the notion that a trader will become much wealthier, in a shorter time, from this than from any other method of trading. While this is possible, in my experience most traders who have achieved such success have done so through sheer luck rather than by applying solid trading techniques.  

In any market the higher the risk, the greater is the knowledge needed to manage that risk. However, many traders mistakenly believe they already possess the required knowledge and skills to trade the highly leveraged CFD market. As any trader who earns a living from the share market knows, to be successful trading CFDs in the long term you need to have the knowledge, the skills and yes, maybe a little luck - although the harder I work at my trading the luckier I become.  

You need trading strategies that will ensure your long term success. In this article I will introduce you to a trading strategy that can generate good results when combined with solid money management rules.  I am amazed at how many people attempt to trade CFDs with a trading plan that is a disaster waiting to happen. Traders commonly use a trading rule or technique out of context, usually in regard to short term trading. They learn something in a book or course that they think is fantastic, and then they attempt to apply it to their trading - without testing whether it works.  

However, it is important never to test anything in the market until you have back tested it on the stocks you intend trading. What I will share with you works. But you must practice it before applying it in the market.

Developing a short-term CFD trading plan

You must consider two major elements: the medium to longer term trend of the stock or market you are trading; and the use of short term entry and exit rules to manage the trade.

Regardless of your trading strategy, it is important to consider the next larger time span to the one you are analysing, as price and time will usually always conform to the next larger trend. If you are analysing a daily chart you need to respect the larger trend on the weekly chart. Similarly, if you are analysing the weekly chart you need to respect the trend of larger degree on the monthly chart.

Your analysis should be completed on the weekly chart to establish the direction of the trade. The daily chart just provides your entry and exit for trades of up to a few weeks once the direction is established. If you fail to trade with the longer term trend, you will not only be inconsistent in your trading outcomes, you will be taking higher risks. Rules that can assist you in determining the longer term trend include Gann or Dow Theory, trend lines and cycles analysis.

Once you have analysed the longer term trend, you need to determine entry and exit rules and your money management strategy. I have found successful entry and exit rules for profitably trading short term include Gann’s counter-trend theory, Dow Theory and Gann Swing charts.

Gann swing theory

This is a very simple technique that helps to dramatically increase the probability of success and to reduce the level of risk you take each time you trade. Swing charts are a very simple visual aid to assist in determining the strength (momentum) and direction of a stock (or market) with regard to price, thus keeping you out of losing trades. While swing charts are best used when combined with other analysis tools they can be used in isolation, a technique referred to as ‘swing trading’.  

Swing charts also enable you to analyse a great range of data at any one time, allowing you to study long periods of time more easily.

Entering a long trade

Once the direction of the stock you are analysing is confirmed on a weekly swing chart by the presence of higher swing highs and higher swing lows, you buy (trade long) when the price rises $0.01 above the previous swing high after confirmation of a higher swing low as shown in figure 1.  

Figure 1:  Weekly swing chart –  

Buy signal example

In the example in figure 1 the stock confirmed a higher swing low at $1.05; then rose to break through the previous swing high of $1.30. When this occurred you could buy the stock and enter into a long position at $1.31. 

Figure 2 is a weekly swing chart of Sonic Healthcare (SHL), which demonstrates where we entered a long trade based on Gann Swing Theory. Notice that after confirming a swing low at point 1, SHL moved up strongly to confirm a swing high at point 2. At this point we couldn’t buy because the stock had not confirmed a higher swing low. SHL then moved down to confirm a higher swing low at point 3 before turning to trade up above point 2, triggering an entry.  

Managing a long trade and setting your stop loss

When trading long using Gann Swing Theory, your initial stop loss is set $0.01 below the previous swing low or when price retraces to break through 50% of the preceding swing range as shown in Figure 3. During the trade your stop loss is continually moved up to act as a trailing stop loss until you exit the trade.
 
Figure 3:  Trailing Stop

The Exit

Figure 4 shows that upon entering the trade in Bluescope Steel (BSL) the initial stop loss is set $0.01 below the prior swing low (point 1) or 50% of the previous swing range (point 2). Once again we trail the stop loss up, which in this example is $0.01 below each successive swing low (points 3, 4 and 5) until we exit the trade, once  price trades below point 5. As an alternative stop loss method, we could have used 50% of the previous swing range, which in this example would have kept us in the trade for the same period although our exit would have been triggered at a higher price.

Entering a short trade

Once direction is confirmed on a weekly Swing chart by the presence of lower swing highs and lower swing lows you would sell (trade short) using a Swing chart when price falls $0.01 below the previous swing low after confirming a lower swing high, as shown in figure 5.

Figure 5:  Short Trade Example

In the example in figure 5 the stock confirmed a lower swing high at $1.20, then fell away to break below the previous swing low of $1.05. When this occurred you could have entered into a short position at $1.04.

Figure 6 is another weekly swing chart of Sonic Healthcare that shows where to enter a short trade based on Gann Swing Theory. After confirming a swing high at point 1, SHL moved down strongly to confirm a lower swing low at point 2. SHL then rose to confirm a lower swing high at point 3 before turning to trade down to move below point 2, triggering an entry.

Managing a short CFD trade and setting your stop loss:

On entering a short trade, your initial stop loss is set at either 50% of the previous swing range or $0.01 above the previous swing high as shown in Figure 7.  
 
Figure 7:  Trailing Stop to Exit

As the trade unfolds, the stop loss is continually lowered to act as a trailing stop until you exit the trade.

Figure 8 below shows that upon entering a trade on Telstra (TLS) the initial stop loss is set $0.01 above the prior swing high (point 1) or 50% of the previous swing range (point 2). Once again, trail the stop loss down. In this example $0.01 below each successive swing low (points 3, 4 and 5) until the trade is exited once price moves above the swing high at point 5. As an alternative stop loss method, we could have used 50% of the previous swing range, which in this example would have seen us exit the trade prior to the swing high at point 4. 

Remember that the shorter term trend will always conform to the longer term trend. Therefore when trading over the short term using swing theory, you need to ensure both the daily and weekly charts are pointing in the direction of the trade you are taking. It is also strongly recommended that the monthly chart is pointing in the direction of the trade, so that you know the longer term momentum is with the trend.

Adhering to these rules may be hard when a stock moves in the direction you want and the swing chart keeps you out of the trade for a time, resulting in your entering at a higher price. While at times this may happen, you need to stick to these rules rigidly, as they will greatly reduce the risk you take when trading. They will also save you from entering losing trades. 

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