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Hedging/price protection
The ability to 'hedge' against market volatility and provide a degree of portfolio protection is another (and often overlooked) benefit of trading CFDs. This benefit, however, is best explained by way of a short example.
In this example, our investor has a substantial portfolio that contains a broad selection of UK Stocks. With a UK economic update days away, he is concerned about how this might affect the short-term value of his Stocks. He is, however, more confident in their long-term prospects. In order to ease his concerns and protect the value of his porftolio, he decides to sell (or rather with CFDs 'short') the FTSE 100. Therefore:
- If the FTSE falls, the UK Stocks within his portfolio may lose some of their value. The CFD positions he has taken may, however, make a profit (as he made a speculative bid that the market will fall).
- If the FTSE rises, the UK Stocks within his portfolio will increase in value and these gains will offset the loss he has made with the CFD position he had taken.
So, by using CFDs an investor can take steps to easily protect their portfolio from volatile price swings in the market.
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