Markets drive clever traders to scalping
In sentiment-driven times, CFDs offer plenty of tricks and tactics, says Katie Hope
With most things in life, the better you’ve planned, the better things are likely to go for you. But any boy scout applying the trusty “be prepared” motto to his investing tactics of late is likely to have been disappointed. Shares and the wider market have moved around seemingly on a whim: one day a higher oil price boosts heavyweight oil shares such as BP and Shell, the next they fall even as the oil price continues to rise.
It’s the same with earnings announcements. Last week US bank Merrill Lynch announced a $4.65bn loss for its second quarter, worse than even the most pessimistic of analysts had expected, yet the next day the banking sector on both sides of the Atlantic continued to rally.
Fear, greed and the good old herd mentality – often said to be the sole drivers of share price movements – are back in vogue with “fear” seemingly the dominant emotion among investors.
For a contracts for difference (CFD) trader, such abrupt and unexpected changes in market sentiment causing irregular and sharp price movements can derail a trading day. For one who has not had the chance to close open CFD limit positions below or above the market level, it could spell disaster.
Crucial yet intangible
“Market sentiment is a crucial yet intangible aspect of trading,” says Martin Slaney, head of derivatives at CFD and spread bet provider GFT. “Often it is the most important factor in determining a market’s direction, but it can be a frustratingly elusive factor to quantify. Ultimately, if you are trying to assess market sentiment you are attempting to take a snapshot of the psychology of a market.”
Assuming your strength is not crystal ball gazing, what is your best tactic? Tim Hughes, head of sales at CFD provider IG Markets, says that the first step is to acknowledge the conditions and to trade accordingly.
“Buy into good news, perhaps, but don’t expect it to last. You’ve got to be on your toes, but also employ fundamental techniques of using stop losses and trading discipline. These should combine to see you win more on your good trades than you lose on your bad trades.”
But, as well as adapting your trading according to the conditions, there are actual opportunities to use the current volatility to your own advantage.
A method of speculation some CFD traders use involves stacking limit bids and offers above and below the current market best bid and offer spread (BBO) at different tick increments. The aim is to capitalise on short term price movements away from the BBO that then revert to the mean price.
“If a CFD BBO is 330-33 on a stock, a CFD trader often places limit bids at 329, 328, 327 and 326, and offers at similar price intervals above the offer price to capture any short term blips up or down in the price.
The expectation is that any short term blips will soon rectify themselves by returning to the BBO 330-33 level promptly, thus making trades beneath or above the market profitable,” explains Dave Norman, an ex-trader who now risk-manages traders.
Scalping for cash
A similar strategy is so-called “scalping”, which takes advantage of the trading volume at the bid and offer price of an instrument. If wheat, for example, typically has a BBO of £6.34-6.36, then a scalper will establish long positions at, or below, the bid price, and short positions at, or above, the offer price.
By sitting on the bid and the offer, it’s possible to capture sellers and buyers simultaneously and make regular small profits from the spread. The wider the spread becomes – and typically more volatile conditions mean wider spreads – the more profit potential scalping offers. (See box for advantages and disadvantages of scalping).
Another way to profit from the current sentiment-driven markets is to use what is known as a “contingent order”.
Gold, which everyone is currently watching to see if it will return to $1,000 an ounce, is a good example. A trader can use an “if done” order so that if the price of gold reaches a defined level then a sell is generated.
This means he is short of gold on the belief that profit-takers will drive the price lower, but the “if done” order will also trigger a corresponding stop order, offering a degree of protection against adverse market movements.
Oco-motive
“For example, sell gold if the price reaches $1,000/oz with a corresponding buy position at $1,020,” says Jimmy Yates, senior dealer at CFD and spread bet provider CMC Markets. “Once the $1,000 level is hit a sell order is generated. If the price falls back the trader is in profit. If the price rises, the trader moves into deficit, but losses are capped at $20 multiplied by the size of the position.”
Yates also suggests a “one-cancels-other” (OCO) order ticket. In this instance you can place two orders in one go and the first one to be triggered will immediately cancel out the other.
If for example, gold is stuck in a range between $900 and $1,000, then an OCO can be placed with a sell order at $1,000 and a buy at $900, meaning that regardless of where the price goes, a trader’s strategy will be actioned.
If he expects gold to break out of this range, he can reverse the positions to buy at $1,000 and sell at $900, the critical part being that as soon as one part of the order is filled, the other part is cancelled.
You can’t see into the future, but even in current conditions there are strategies that can help you to be prepared for the wild swings in direction, and potentially even make some money out of them. Maybe those scouts knew a thing or two after all.
