CFDs and spread bets should never form the basis of a long-term investment strategy. Both are margined products which employ leverage. These products are speculative in nature and suited to shorter-term positioning. Consequently, it would seem that portfolio diversification trading isn’t really an issue for anyone holding a spread bet or CFD account.
Not only that, but there are so many stock indices and ETFs around that it seems very easy to pick up a diversified exposure to, say, the UK equity market simply by taking a position on the UK100 index. This is true to some extent. However it’s also vitally important to have some understanding of what goes into a stock index. Just considering the UK100 for a minute, it is estimated that around 70% of earnings from the index’s constituents come from overseas. This is one of the reasons why the sharp sell-off in sterling which followed the UK vote to leave the European Union back in June 2016 helped to boost the UK100 index.
The cheaper pound was a direct benefit to any UK company who manufactured their products domestically (with relatively little reliance on imported raw materials) and then sold these overseas. Not only were their goods cheaper for foreign buyers, meaning higher sales, but the foreign currency proceeds showed up as higher earnings when translated back into sterling. So, this example alone shows not only how important it is to know what companies are in a particular index, but also how a big currency move could affect the index itself.
After all, you may have sold the FTSE100 ahead of the referendum expecting a “no” vote, only to lose money thanks to the direct effects of the currency move on the index. For comparison, the more domestically-focused FTSE250 had a markedly smaller reaction to the fall in sterling.