One of the important parts of developing an effective strategy for CFD trading is understanding the relationships between different assets that affect movement in the market. Those relationships are usually referred to as correlations, and they can be helpful for traders to better make decisions and be more accurate in predicting trends.

Assets may move differently to each other. There are positively correlated assets, and they move in the same direction. For example, when the price of oil goes up, some energy-related stocks also go up. Conversely, assets can be negatively correlated as well; they move in opposite directions. One example is between gold and the US dollar. When the dollar increases in strength, gold generally falls in price, but when the dollar weakens, gold tends to increase.

Knowing this correlation, the decisions the CFD trader can now take are more insightful. Let’s say a trader ascertains that a stock he owns is very positively correlated to oil prices. Then perhaps as a hedge to a long position in that particular stock, he will decide to open a position in the future of oil or through the CFDs in order to reduce the detrimental market movements that will otherwise impact his investment.

In CFD trading, a trader does not own the underlying asset but speculates on its price movement. This means understanding the dynamics of the market is all the more crucial. The correlation between the assets helps traders determine if they should go long, which is to buy or short, which is to sell the CFD. For example, a trader will open a long position on the CFD for the stock if he or she thinks that a given stock is likely to perform well because oil prices are going up. He or she can open a short position on the stock CFD in case he or she foresees the decline in oil prices.

Traders can also diversify their portfolios using the correlation. Careful selection of assets having negative correlation can help reduce the risk of a portfolio in the hands of a trader. For example, if one thinks that equities are going to go down then safe haven assets like gold or government bonds come into the picture because these assets will perform well in uncertain times. Trading with these assets by using CFDs allows them to balance their risk exposure and potentially make capital out of price fluctuations both ways.

It is a skill that matures with time and experience, but one can interpret these asset relationships. Traders typically utilize correlation matrices or software tracking historical price data to spot these kinds of patterns. After a trader identifies these correlations, he or she can design strategies that are in tune with market trends, be it to capitalize on positive correlations or hedge against negative ones.

The deeper insight that is garnered into the market conditions from monitoring how various assets react relative to each other may help the CFD traders make more accurate predictions. This, in turn, enhances their chances of succeeding in this highly competitive world of CFD trading as they successfully manage the risks.