When, Why, And How To Close A CFD Position? - A Complete Guide
In the previous article, we discussed on opening a CFD position. In this article, our focus will be on how to close a CFD position.
We have seen how easy it is to open a CFD position. What if I tell you it is even easier to close a CFD position. Let us understand how CFD trading works so you can get a better understanding of closing CFD positions.
CFD Trading Basics
CFD trading allows you to speculate on the increasing or decreasing prices of financial instruments.
Two parties (client and the broker) form a contract where they exchange the differences in the opening and closing price of the financial asset they are trading.
The common CFD assets include commodities, indices, shares, and cryptocurrencies. According to your prediction or speculation, you either win or lose money.
Let’s understand CFD trading with the help of an example.
Consider a forex trader, who mainly deals with the pair USD/JPY. The buy price for this pair is 113.07 and sell price is 113.09.
The trader will choose to buy or sell depending on his prediction. If he thinks the price will increase, he will go for a long (buy) position, and if he thinks the price will drop, he will go short (sell) on the pair.
Our trader here predicts that the price will increase. So he buys 10 contracts of this asset. His speculation turns out to be right and he closes his trade when the price reaches 113.11.
Thus he earns a profit by predicting correctly. The amount he earned depends on the leverage of the asset. It also depends on the trading fees incurred on this trade.
Closing the trade at the correct time is crucial to trading success. If he gets greedy and waits for the price to increase, even more, he could have faced a loss.
Our main focus on this article is how to close a CFD position.
Closing a CFD position
As we have discussed above, CFD’s are contracts that are formed between the buyer and the seller.
Closing a CFD position refers to ending the contract that we opened initially.
It is terminating the initial exposure that the trader faces when he opens the position.
As we know, unlike stocks and shares, you don’t own assets in CFD trading.
You only speculate on the price movement of the financial instrument.
Now that we know what closing a CFD position means, let us look at the reasons why someone should close a CFD contract.
When and Why Should You Close a CFD Position?
A CFD trader closes his position for the following reasons:
He is satisfied with his profits: The trader has done well on his trade and has earned sufficient profits. He wants to close his trade before the market position moves against him.
To control his loss: The opposite scenario has happened here. The trader has realized the market position has moved against him and he has faced a loss.
He tries to close his position as soon as possible in order to keep the loss to a minimum.
Maintaining the position gets expensive: CFDs don’t have any expiry on them. But that doesn’t mean you should hold them indefinitely.
One of the costs associated with CFD is the overnight financing cost that is incurred when you continue your position overnight.
Some traders prefer to day trade because of this overnight financing cost. CFD trading is suited mostly for short-term trading.
Keep in mind that only those traders who hold a long position are subject to this fee.
Now that we know when and why you should close a CFD position, let us get to the crux of the article.
How to Close a CFD Position?
Closing a CFD position is quite simple actually. You can close it manually or set some stipulations so that the broker will close it automatically for you.
Let us look at each of the methods separately.
Closing a CFD Position Manually
To close a CFD position by yourself, just perform the opposite of your initial action.
So if you opened a long position, sell it to close your trade. Similarly, if you went short on a trade, buy it back to close the trade.
The interface for closing positions differs from platform to platform.
On some platforms, you can close your position by just clicking on the ‘X’ button, while on some platforms you have to click the opposite action of your initial position.
Closing a CFD position using Stop Losses and Limit orders
Stop losses and limit orders play an important role in CFD trading because the market is so volatile and unpredictable.
These stipulations ensure risk management and minimize losses for traders. Let us look at the different types of stipulations that stop your trade when necessary:
A stop loss order closes your trade when the price of the asset reaches a certain level. This order proves to be extremely helpful when the market quickly moves against your position.
By closing your trade at a certain price level, you are controlling or minimizing your loss.
You are also falling short of your profit potential by closing your trade beforehand. Stop losses don’t often execute immediately due to slippage in high volatile assets.
Guaranteed Stop Loss Order
This stop order functions in the same way as a stop order except that executing this order is guaranteed is to stop your order regardless of market volatility and slippage.
Adding a stop loss is free but adding a GSLO requires a premium fee.
Trailing stop order
In a trailing stop order, the stop-loss price is not set statically, but rather dynamically.
The trailing stop price moves along the market price. If the market price moves up by 5 points, the trailing stop goes up by 5 points as well.
You need to set your trailing stop percentage which would set the trailing stop order.
This order is used along with Stop orders to further customize their risk management.
What this order does is simply close your position after you have reached a certain profit level.
If the opposite happens, i.e. the market moves in the opposite direction, then the stop loss order is executed.
The aim of this article was to make the concept of closing a CFD trade clear to you.
We understood the concept of CFD trading with the help of an example and understood what closing a CFD trade means.
Then we understood when and why you should close your trades. Finally, we learned how to close CFD trades either manually or using orders such as stop-loss, trailing stops, or take-profits.
Closing trades at the right time is important due to the volatility of the market or else you will lose money.