Knowing Your Risk when Trading CFDs - dummies

Knowing Your Risk when Trading CFDs

By David Land

Part of CFDs For Dummies Cheat Sheet (Australian Edition)

When it comes to leveraged financial trading, managing your risk is paramount. When starting out in trading CFDs, many traders think that knowing their entry and exit signals is the key but this really runs in second place compared to preserving capital — without capital you can’t trade, no matter how good your entry signals are.

When it comes to knowing your risk, there are some important points to remember:

  • Don’t over-leverage. The amount of leverage you allow yourself should always reflect the amount of capital you have in your trading account — and you should be aiming for about 3× leverage on your capital. For example, if you have $10,000 in your account and hold $30,000 worth of positions, you have applied 3× leverage to your capital. While the leverage that you have applied to an individual position may be much higher, always remember to check the broader picture of your total leverage and keep it under control.

  • Don’t open too many positions. A lot of people focus their energy on finding the CFD provider that offers the lowest margin requirement but then go crazy opening multiple positions and end up using all their available capital. This is a mistake — because of the effects of leverage, all it takes is one bad trade and your trading capital could be wiped out. Always keep plenty of spare cash available.

  • Know the conditions under which you will exit a trade before you get in. If you do this, you can work out what a losing trade will cost you before you make the trade.

  • Don’t assume your exit point will be exactly where you have set your stop loss. To varying degrees, ‘gapping’ can occur in all markets. This means that your stop loss will be executed at a worse price than you anticipated, costing you more — depending on the market, sometimes a lot more.