There are numerous trading strategies that CFD traders are currently using. Strategies may vary from pairs trading to arbitration plays, portfolio hedging and more complex butterflies. I want to discuss a very basic strategy that many traders are using although there are traders out there that are still oblivious to this strategy.
Those of you who follow Rugby League will be familiar with the 40-20 rule. This is when you are defending your try line and you kick the ball from your 40 meter line and it goes into touch in the oppositions 20 meters. If successful with the kick you get an attacking scrum feed. So you have turned a defensive kick into an attacking position. What does this Rugby League play have in common with CFDs?
CFD traders are using a trading strategy called the 80-20 rule. This occurs when you hold equity CFDs and sell the Aussie 200 CFDs to hedge your position. An example of this is when you have a portfolio of long equity CFDs, say to the value of $100,000. To hedge against a sudden downturn in the market you sell 20% of the face value on the Aussie 200 index. Thus if the Aussie 200 index is trading at 6300 you would sell 3 contracts or $18,900 worth (closest to $20,000 face value). The 80-20 rule can soften the blow when the market goes down and it gives the CFD trader a more comfortable sleep at night. The percentage of hedge will vary as the market momentum changes, although the way markets have been of late 80-20 is ideal.
For traders to utilise this strategy they will obviously need access to the index. This is very important as some traders try to hedge by selling individual stocks as they can’t sell the index. This strategy is very dangerous as the Private equity firms are still out there swimming around looking for a feed; you don’t want to be their dinner.
To return to the 40-20 rule in Rugby League; the smart players can turn an average territorial position into a strong attacking play. The 80-20 rule acts in the same way; CFD traders use a basic strategy to protect their capital; mitigating losses and positioning themselves for stronger, safer wins while the full time siren is ringing on the bull market and the CFD trader with no game plan.
Hamish McCathie, Director, CFD Trading
Disclaimers: The views expressed in this article are those of Hamish McCathie, a representative of CFD Trading and is not intended as general advice. This does not constitute a recommendation nor does it take into account your investment objectives, financial situation nor particular needs.