Stock index CFDs
offer a handy way to hedge existing stock positions in
erratic markets; as CFDs can be traded long or
short traders are able to open a short position
on an index that is representative of their stock portfolio, knowing that any losses in
their stock portfolio will be balanced by their index CFD position.
As an example, a
backer might hold a balanced stock portfolio across the
Australian market. He is anxious about
short term volatility and his assets
falling in value but doesn't want to
sell his positions as he expects the market to trend
up over the long term.
As an alternative he comes to a
decision to offset possible losses by opening a short
position on the Australia 200 Index. As an index is a
probabilistic measure of the value of a
bunch of stock, it will rise and fall with the
changing cost of individual shares.
He sells, or goes short on, numerous Australia 200 contracts, realizing
that now his share position is hedged if the market fluctuates. For
every dollar he loses on his share portfolio, he will gain a dollar on his Australia 200 position.
Similarly, for every dollar he loses on his index position,
he'll gain a dollar on his share
portfolio.
From here there are three possible
scenarios: the stock and index appreciate in
value, the stock and index decline in
value, or the stock and index trade sideways.
One. The stock and index go up in value
The market continues trending upwards, and his
portfolio is soon worth another 10,000.
However, as the investor had sold the Australia 200 with the hope that it would go down, he has made
a loss of the same quantity on that position. If he
suspects the market will continue to go up,
he could close his Australia 200 position and continue
enjoying to profits of his share
portfolio. If he still thinks there are unstable times
ahead, he could keep that position open, realizing that
any possible losses will be counterbalanced
by his share portfolio.
Two. The stock and index fall in
value
If the investor loses 20,000 across his
portfolio, he will make the same profit on his
Australia 200 index CFD position, which would annul
those losses. Once he believes the price has bottom out, he could close
the index position, taking those profits and holding onto the stock
until its price raises again.
Three. The stock and index remain flat
The trader won't
have made a profit or loss on either trade.
Index CFDs are a helpful tool
for safeguarding existing investments against price
fluctuations, and CFDs generally are a neat method to quickly diversify your portfolio with minimum
capital needs. That being said, this strategy is a
market-neutral strategy, meaning that although you will
not make a loss, you will not make a profit either
for as long as both positions are open. Hedging can lower
profit potential, but as it also
limits losses, it can reward traders with a steadier flow
of profit over time.
Remember that CFDs and forex are leveraged products and can result in losses that exceed your first deposit. CFD trading may not be appropriate for everybody, so please make sure you understand the risks concerned.
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