Using CFD Technical Analysis to Make Better Trading Decisions
Technical analysis can help you get a better understanding of potential trends in the stock market, but how can you actually analyze trends for CFDs?
Published January 14, 2024.
Contract for difference (CFD) investments are financial derivatives that let traders speculate on the price movements of a wide range of instruments without owning these underlying instruments. The CFD trading model can be used for stocks, commodities, indexes, and currencies. CFDs are usually popular for traders who utilize leverage since they require smaller upfront capital to open a position.
Technical analysis could be a valuable tool for some traders. Seasoned investors will employ the means of technical analysis as a way to evaluate and forecast future price movements of these financial instruments. This typically consists of studying price charts and assessing trading volume, complemented by indicators like oscillators, moving averages, and resistance levels.
Understanding CFD Technical Analysis
Using technical analysis for stock CFDs is similar to how you might use it in the conventional way of buying and selling stocks or commodities, though the trading methods are still different—with CFDs, you don't actually purchase ownership of any instruments. You will still formulate trading strategies, identify entry and exit points, and manage your risk more effectively.
Now, there are particular principles and tools that you can integrate into your technical analysis. The three primary tools are chart patterns, indicators, and trend analysis:
Chart patterns show up often in instrument prices and are widely considered to indicate potential movements. Three of the most popular ones include:
1. Double Tops
A double top indicates a potential reversal in an upward trend as traders are seeking to capitalize on a bullish trend. You can spot it by noticing two consecutive peaks with a slight decline between the two, forming a rough "M" shape, as shown below in the performance of the stock price of certain British pharmaceutical company:
2. Double Bottoms
On the other hand, a double bottom is considered the opposite of a double top and could indicate the reversal of a downward trend. You can spot this by noticing two consecutive troughs that form a "W" shape, as shown below in the performance of the stock price of a European defense contractor:
3. Head and Shoulders
A head and shoulders pattern indicates that a trend is potentially about to reverse from a bullish trend to a bearish trend. In this pattern, the head (middle peak) will be higher than the left and right peaks (shoulders), as shown below in the performance of the stock price of an US insurance company:
Like chart patterns, indicators could also be used to identify potential trends in the market. Here are two examples:
1. Simple Moving Average
This is the average of previous price data (such as the closing prices) over a specified period. Calculating the moving average could give an indication of the direction a stock is likely to move.
Example: if you are incorporating moving averages into your CFD trading endeavors to confirm a pattern, you could look at the 50-day simple moving average (more suitable for short-term) and 200-day simple moving average (more suitable for long-term). If the 50-day crosses the 200-day, it could unveil a bullish signal.
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2. Relative Strength Index
This is a gauge of the pace and change of price movements, which could help you determine if conditions are overbought or oversold, giving insights into potential future trend reversals or price corrections. You can calculate it with the following formula:
RSI = 100 - [100 / (1 + RS)]
- RS (relative strength) = ( average gain / average loss )
- Average gain = ( sum of all positive price changes in your specified period ) / number of periods
- Average loss = ( sum of all negative price changes in your specified period ) / number of periods
You should get a value between 0 and 100, where everything above 70 is considered "overbought" and could indicate a potential price reversal, while below 30 is considered "oversold" and could indicate a potential price increase.
Potential Advantages of Using CFD Technical Analysis
1. Enhanced Understanding of Market Dynamics and Price Movements
CFD technical analysis enables traders to obtain insights into the behavior of financial instruments by looking back into history and combing through price data and chart patterns. Whether identifying trends or perusing key performance indicators, you can garner a sense of where price levels could be traveling.
As an instance of this, let's say that you are trading Microsoft or Ford Motor, and the stock is regularly hitting a resistance level. At the same time, you come across a bullish trendline, which means the security could break that resistance and initiate a bullish run on the horizon.
2. Improved Timing and Precision in Trading Decisions
Attempting to time the market is considered a dangerous decision for young traders without any experience. However, you can always improve your timing and precision by using technical analysis. Put simply, CFD technical analysis extends you the possibility of completing better-timed decisions.
» Looking for an alternative instrument with CFDs? Learn more about trading agricultural commodities with CFDs
Improve Your Trading Knowledge with CFD Technical Analysis
Should CFD technical analysis be your only tool? Of course not. Instead, it should complement your overall trading strategy since it could be a helpful aspect of your trading account, including watching the news, skimming through social media, and reading what the experts are saying. Trading is about knowledge, and having a treasure trove is critical.