There has been a surge in volatility over the past few months, creating both trading difficulties and opportunities. Dave Limburg takes a look at how to approach volatility using CFDs.

Firstly and most importantly your trading needs to disciplined! Volatility equated to larger price swings in both directions – up and down, creating opportunities both long and short. Set stops; make sure you stick to your stops! All CFD providers allow for stop losses to be set. This is the backbone of good trading. Given that the markets are more volatile, consider reducing your position size to allow for the larger price variance, this will also allow you to widen your stop loss to avoid be whipsawed out a trade.

The major advantage that an increased volatility offers is large, quick gains that a less volatile market wouldn’t offer. Currently the all ordinaries index for instance is producing 100 point days, as opposed to 40 point moves in the previous months. One could benefit by placing an intraday trade and picking up say 60 points without the risk of holding overnight.

The above chart illustrates the increase in volatility from the chart breakout at the start of August. Note the range of the days prior to August, and the increase post August.

A successful trade for me where I took advantage of this increased volatility was on 4 August. The daily chart had broken out to the downside the previous day at 4480, giving an initial downside target of 4282 (4695 top - 4497 bottom=198 point range subtracted from the breakout point). There was clearly plenty of downside over the coming days. Intraday the market rallied in the morning before breaking down, I shorted the market at 4420 (with a stop at 4430) and rode the downtrend throughout the day, closing out my short before the end of the day at 4362. This trade gave me a nice 58 point profit with relatively little risk.

CFDs allow you to leverage your account both long and short. Leveraging your positions allows for potentially larger gains (and conversely larger losing, again reiterating the importance of stops). CFDs can mean a price movement of 5% can be leveraged into a profit of 50% or even more ROI.

Lately I have been actively taking advantage of this volatility and CFD leverage to trade the spi index intraday, making nice gains without the risk of holding overnight. However everyone has their own trading methodology and timeframe, this works for me; however the same principles could be used over days, or weeks. A longer time frame may suit more passive traders who perhaps don’t have the option of watching the market intraday. CFDs still allow you to trade with leverage, set your stops and also set targets to close out your trades, all without you watching the market in real time.

Currently the markets are creating some challenges, however a flexible trading strategy that allows both long, and more importantly at the moment, short trading can take advantage of the opportunities arising. The main trading principle that will assist you is discipline – always remember your stops!

Dave Limburg is a fulltime day trader, trading CFDs, options, warrants and equities. He also runs The Everyday Trader educational website.