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Trading contracts for difference (CFDs) is a way of speculating on the movements in various markets, from shares to currencies to commodities, such as gold. It’s exciting, heady and psychologically challenging, drenched in the emotional agony of loss and the euphoria of winning. But there are ways to do it successfully if you have the mental discipline.

Steady nerves and a respect for the rules will pay dividends when markets are gyrating wildly. Trading choppy markets like these can be like trying to tame a cornered possum – every attempt results in a nasty bite. Yet the best traders thrive in such conditions, finding that the same volatility which makes markets whipsaw also provides some of the biggest opportunities.

Lesson 1: Reduce position sizes

The first lesson for less experienced traders is to reduce position sizes and allow stop-loss orders more room to move. If you’re trading according to good risk management rules, changing the place where you are willing get out at a loss also means reducing your position size.

Here’s why. Suppose $100 represents the whole of your risk-trading capital. As a serious trader you can’t afford to lose more than $1 of that amount on each trade (1 per cent of your capital). It’s not impossible to have seven, eight or even 10 losing trades in a row. If you risk 5 per cent on each trade, and five of them lose money, a quarter of your trading capital is gone.

That’s far too much as a proportion of your total to lose in the space of a few days or weeks. To trade safely, you should set your stop-loss by reference to such technical factors as the daily range of the commodity or currency, not forgetting support and resistance levels, trend lines, moving averages and the other tools you use to identify trend changes.

Suppose you buy gold at $US1850 an ounce and place your stop-loss, after studying the charts, at $US1800. If the stop is triggered, you will lose $US50 an ounce and if your trading capital is $50,000 you can afford to lose no more than $500. Your maximum position size will be 10 ounces (roughly, the $500 loss limit divided by the $US50 stop-loss, ignoring currency risk).

Lesson 2: Diversify

Try trading a range of markets rather than just the local sharemarket and currency. When the Australian dollar isn’t moving, look at the euro against the US dollar, the Swiss franc or the yen. Add potential trades to your portfolio by diversifying into indexes over the various global stockmarkets.

Lesson 3: Sell short

Many traders still either forget you can short sell or are nervous about it, seeing it is more risky than buying. It can be, because markets often fall faster than they rise, but this also provides opportunities.

With global equity markets apparently about to enter a phase of drifting lower, or even plummeting sharply from time to time, overcoming your psychological resistance to short selling (agreeing to sell what you don’t own to profit from a price fall) potentially doubles your trading opportunities.

Lesson 4: Learn about options

Now offered by a number of CFD providers, options over a share index can provide new opportunities. You can buy index CFDs, for example, and have a cushion against an overall market fall through buying put-index options. Options can be complex but an option hedge can give your strategies added flexibility.

Lesson 5: More discipline

According to trader and educator at The Trading Lounge, Peter Mathers, the best way to wrestle with the emotion of trading is to take out as much of the guesswork as possible.

As part of his service to traders, Mathers has a set of simple trading systems for getting practise in trading mechanically – that is, strictly according to a set of technical rules, rather than trying to guess what the market will do next.

One of the strategies involves trading a single stock, CBA, on the premise that there is always a trade in place. The system, which Mathers calls “Robo Trade”, uses price and volume data to identify a point at which to buy and signals when to exit. Whenever a buy trade is exited, a new trade is made in the opposite direction (sell). Mathers says that between March 2011 and August 2011 the strategy had returned 105 per cent.

Another strategy involves a wider range of stocks but allows traders to choose a suitable time frame. Mathers says the strategies are a good way to show traders why they should surrender to the technical rules rather than emotions. The system is designed to allow traders to take a proportion of profits regularly as the trade moves favourably, ensuring some profit is retained if a quick change of price direction upsets the apple cart.

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