Option Trading or CFD Trading?

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When it comes to trading leveraged financial instruments, there are a number of alternatives out there to choose from. I’m about to share with you my thoughts comparing the two most popular of these alternatives - Option Trading and CFD Trading. By the time you’ve finished reading, you will hopefully be forewarned of some of the advantages and traps, based on my personal experience, successes and failures.

I started option trading about five years ago after attending one of Nik Halik’s seminars. My initial approach to the markets was based on a very directional approach. If I expected the share price to rise or fall and I got it right, I made money. If it didn’t go the way I expected, I lost money... simple as that.

As time went on and I gained a deeper insight into how the options market works, it occurred to me that even when I get it wrong, more often than not, I can adjust my position so that I usually don’t lose any money and can even make a profit. The one beautiful word that comes to mind when I think of option trading, is "flexibility".

Consider this example: You’re looking at a chart of a stock that you’ve observed has been channelling between a high and low point over recent months (or even days). It’s an upward sloping channel, which means that over the long term, the stock is trending upwards. You see it come to the bottom of the channel and believe the odds are in your favour, that it will rise up again. But when it hits the bottom of the channel, it does so with a decisive downward thrust. This would normally be good reason for "out of the money" call options to be under-priced, as the market is more focussed on the stock falling, which makes put options more popular.

So you purchase some "out of the money" call option contracts very cheaply. I think they call this "the contrarian approach" - do what everyone else is not doing. From now on, one of three things can happen:-
(1) The stock can bounce up again, as anticipated.
(2) The stock can go sideways for a short time before deciding on future direction.
(3) The stock can break through the channel and continue to fall.

Let’s examine the consequences of these alternatives:
(1) The stock bounces. Because you’ve purchased your call options cheaply, you’ll make an absolute killing - often at least 100 of the overall investment is financed by the market maker. This means that a move against you is magnified 20 times. If the market makes a sudden large move against you, you're exposed to unlimited risk and can lose most of your trading capital whereas with option trading, the most you can lose is the amount of one investment.

CFDs often appear more attractive because they are far more liquid (easy to buy and sell) and there are many more stocks, currencies and commodities you can trade them over, all around the world and with ease, using only one market maker. But they are also very directionally rigid. Once you’re in a position, you’re committed to that price direction. If you change direction, you usually lose money because you can only be committed to one direction at once. With options however, you can hold opposing positions at the same time and adjust your positions until a profit, or at least breakeven, is realized.

About 3 years ago, I made a lot of money in a short time, trading options, once I had learned how flexible they were. Then I got greedy. thought I could make more money trading CFDs because the leverage was higher, so I signed up and went for it. Within a month, I had lost most of my trading capital and had to go back to work.

Give me option trading any day! They far more interesting anyway - and their flexibility and limited risk makes them a much safer way to trade.
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