How you can hedge your portfolio using CFDs

Julie Brownlee, Fsp Invest, 09 Oct. 2014

Tags: cfd, cfds, contracts for difference, hedging, hedging using cfds,

You may think that trading products like contracts for difference (CFDs) are only for making speculative calls on the movement of share prices.

But CFDs have other uses. You can use CFDs to hedge your portfolio.

So how can you use CFDs to hedge your investment portfolio?

Read on to find out…

A brief introduction into CFDs

A CFD is an arrangements between two parties to exchange the difference between the closing price of a contract and the opening price of a contract.

You can go long (potentially profit from a rising share price) or go short (potentially profit from a falling share price).

What makes CFDs attractive to traders is they’re geared products. This means there’s a money multiplier effect at work. This can magnify your profits (or losses) by up to ten times.

It all comes down to trading on margin and using borrowed funds to purchase a financial instrument.

The ins and outs of using CFDs to hedge your portfolio

If you have a long-term investment portfolio, during times of market volatility you might want to protect your positions.

What you can do with CFDs is short the CFD on the share you’re concerned about. Or opt to short a stock market index best reflecting your positions.

Doing this is a short-term solution during times of market volatility.

An example of hedging in action

Let’s say you have an ample holding of Sasol shares. As the oil price is under pressure, you think the share price is going to fall.

So what you could do is short Sasol CFDs to hedge your position.

If Sasol does fall in price, offsetting the losses you incur on your actual shares will be the profit you make in your short CFD trade.

Once you think the share price fall is over, you’d close your short CFD positions.

By shorting Sasol CFDs, you’re covering yourself for losses in your investment portfolio.

So there you have it, how you can hedge your portfolio using CFDs.

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