Share costs move both up and down. Investors who hold profit-making stock portfolios can be faced with the dilemma of the correct way to protect their earnings.

For instance, as a speculator you may have a positive long-term view on a stock in your portfolio, but in the short term, you may well think the share price will remain flat or even fall. When faced with this position you may not need to sell for several reasons, eg. It may cause a capital gains tax event. To help protect your position hedging may be employed.

Hedging is a trading methodology that permits you to defend your portfolio against sudden and astonishing losses. Hedging also gives you increased flexibility to stay in investments when you will otherwise have been compelled to exit at a serious loss. Perhaps the greatest advantage of hedging is you don't need to hedge each position, yet you have the capability to apply a hedge to almost any trade at any time.

A Contract for Difference, or CFD, can be employed as a part of a hedging strategy which can help you to protect an existing stock, CFD position or your total portfolio. CFDs are financial derivative instruments that allow you to make money in both rising and falling financial markets. Since a CFD is a margined product, you may use its leverage to defend the total cost of a position with no need to pay high transaction costs up front for it.

Why use contracts for difference as your hedging tool?

CFDs make effective hedging tools because of the low costs, small margin needs and transaction costs permit you to hedge your stock portfolio for a small part of the cost of the full value of the position. Also most CFDs have no defined expiry date have awfully low minimum ticket sizes which permits you to tailor the hedge to your portfolio. Other benefits include the huge range of local and international share CFDs available, plus the extra advantages of a wide range of instruments for instance indices, forex, commodities and more and the indisputable fact that short CFD positions typically earn interest, make CFDs excellent for this trading strategy.

How does hedging with CFDs work?

So how does it work? It's Three June and you think the price of your XYZ shares will drop. To protect your portfolio from the potential loss, you make a decision to go short by selling Ten thousand XYZ shares as a CFD to hedge your long term position at $2.10.

On 19 June, you suspect the cost of your XYZ share has recovered and an uptrend will resume. Based primarily on this, you decide to close your CFD position by repurchasing the CFD at $1.65, giving you a decent profit of 45c per share or $4,500*.

In this example, you have used CFDs to protect your stock position in the autumn period ( and made a reasonable profit ), but in the long-term your stock have remained in your portfolio and you can continue to catch any farther potential profit.

CFD trading might not be appropriate for everyone so please make sure you understand completely the hazards involved.

• This example does not consider a variety of factors including interest, dividends, commission, difference margin and other charges and charges that might apply