Articles of Interest

Incorporating a proper risk management plan into you CFD trading strategy is the single most important aspect of CFD trading. Risk management involves determining the amount of money that you wish to allocate to each trade to ensure that you are able to continue trading should you sustain a loss on the position.
 
Trading CFDs without a proper risk management strategy can expose you to unnecessary risk. For example, if you allocate a large portion of your trading capital to a trade without a proper risk management strategy, you put all of your trading capital at risk meaning that if you sustain a loss you will no longer be in a position to trade. Losing your entire capital base can force you out of the market and you will not even have the opportunity to recoup your losses.
 
The most common form of risk management is position sizing this is also known as the fixed dollar trade size model. In this example an equal amount of capital is used for each trade.

For example, if you have $100,000 to invest, you need to figure out how much to put into the trade. To figure this out you would simply divide $100,000 by the price of the CFD. If the last traded price of the CFD was $8.50 you would divide this by $100,000 to determine the amount of CFDs you can buy, in this case the number would be 11,764. 

In order to determine the amount of risk involved in the trade you will have to work out how much you can afford to lose if the CFD moves against you and set your stop loss at this point. This is also known as the stop loss distance, which is the distance between the entry and stop loss price.

For example, if your stop loss is $8.00 and entry price was $8.50, this means that your stop loss distance would be $0.50. If you have 10,000 CFDs your risk would be 10,000 multiplied by $0.50 or $5,000. In this case your risk would be $5000, which equates to the amount that you could lose should the trade move against you and you get stopped out. 

It is also important to factor in the cost of commission and any financing charges that you may have been incurred from holding the position overnight.

In the fixed dollar trade size model the number of CFDs that that you buy and sell each time will not always be the same, this is because the stop loss size will vary depending on the risk appetite that you have on the trade.

Another form of risk management is compounding, this means that as your account balance increases, you are able to open larger positions.

For example, if you have a starting balance of $100,000 and you have determined that you can afford to have 10 trades open at any given time. As your account balance grows, you will be able to take on larger trades. This strategy can be used up to a point when your drawdown gets too big for your liking and risk appetite.

It is also important to note that if you are trading a CFD that has liquidity issues, you may get to a point where your trade sizes are too large.

To understand more about CFD trading and how you can manage your risk you can download our free CFD Guide.

Before you start trading Contracts for difference it is important to obtain a few tips from the professionals to make sure that you do not make many of the costly mistakes that newbie traders make. Below are three trading pointers which will help you in your CFD trading success.

1. Manage your Positions
Repeatedly new traders spend a significant amount of time selecting, planning and executing new positions, however they regularly make the mistake of exiting these trades with much less thought. This is unfortunate as it is the exit which will determine whether a trade has been profitable or not.

It is human nature to take profits hastily while the concern of incurring a loss will see the same trader leaving poorly performing positions open in the hope that prices will move in the correct direction and reduce losses or even turn them into profitable trades.

Numerous new traders forget about the old saying “Let your profits run and cut your losses short”. As the proverb states if you have a profitable position, it is best to allow that trade to realize its full potential, as opposed to closing it out at the very first sign of a small return. On the other hand, if you happen to hold a position that is moving against you, it is best to move quickly to exit that position, before the loss becomes too great.

If you're managing your trades properly, your average winning trade should be significantly larger than your average losing trade. Once you have the discipline to buy and sell in this way, you should be able to achieve overall profitability even when only half of your trades are winners. A lot of traders make the mistake of not closing poorly performing positions fast enough. One tool that makes this less complicated is a stop-loss order.

After you have determined a price level that corresponds with the amount of risk that you are prepared to take on a particular trade, a stop-loss order can be placed at this level to automatically close out the trade. This removes the human aspect from the exit, reducing the risk that the emotion of hope will interfere with rational decision making.

It is important to understand that a stop-loss order simply provides a trigger point for the execution of an order. If a sell stop has been placed on a long position, the stop-loss will be activated if the price trades at or beneath the nominated stop level. Occasionally, this may lead to trades being executed a price that is less favorable than the nominated stop-loss price. This is known as slippage.

2. Understand the instrument that you're trading
Being over-the-counter products, there are various differences in the contract specifications of CFDs. If you are thinking of trading these products, it is critical to know what these specifications are.

You must also be aware of the influence that foreign exchange fluctuations might have on your holdings. If the base currency of the CFD rises against the base currency of your account your profits could be eroded by any currency fluctuation or your losses might be made worse.

Most CFD traders trade CFDs based on stocks listed in their home country. The simple reason for this is that traders are more comfortable trading CFDs that they're familiar with. Most traders also benefit from the convenience of trading their home market as it isn't practical to sit up for half the night to trade a Contract for difference over a share listed on an exchange in another part of the world?

In lots of cases it is much better to stick with CFDs based on equities listed on exchanges that you're familiar with as opposed to trading Contracts for difference based on stocks listed on markets you don't fully understand.

3. Use the correct order types
You should treat trading as a serious business. As such, you must take some time to make sure that you thoroughly understand the tools of your business. Many CFD traders miss chances or have been stopped up out of trades at the wrong time just because they placed the wrong kind of order.
                   
At the very least, be certain to become familiar with the following order types:

Market order: This kind of order is utilized to execute a trade at the present market price.

Stop-order: This order type is utilized to exit a trade at a specific price. Stop-orders are placed at a level that's worse than prices presently available in the market. On a long position, the stop-loss order to sell would be located below the present market price. Conversely, on a short position, the stop-loss order to buy would be placed at a level greater than present market prices.

Limit order: A limit order is used to exit a trade. Limit orders are placed at a level that is better than the present market price. When seeking to lock-in profits on an open long position, a limit order to sell would be placed at a level greater than current market prices. If seeking to lock-in profits on a short position, a limit order to buy would be placed at a level underneath current market prices.

You must always understand that as Contracts for difference are leveraged and that buying and selling them can be risky. However if used correctly Contracts for difference will become a valuable tool within your trading arsenal.

To find out more about CFDs you can download our complimentary CFD Guide.

Trading mistakes can be made by even the most experienced professionals. Most mistakes made by traders come about as a result of a lack of preparation, knowledge or discipline. Whilst it is important to learn from your mistakes, it is even better and much less expensive to learn from the mistakes of others.

Below are three of the most common mistakes made by CFD traders:

1. Excessive Leverage
One of the main benefits of CFD trading is the ability to gain exposure to a share, index or foreign exchange contract with a relatively small capital outlay. Rather than paying for the full notional value of the CFD position CFD traders can enter into positions with margins as low as 5% or even less. It is important to note that although a smaller capital outlay is required to open the position the CFD trader is still exposed to the price movement of the share CFD for the full notional value of the position. A CFD trader trading a CFD at 5% margin is leveraging their initial outlay by 20 times, meaning a $5,000 deposit could be used to open a $200,000 CFD position.

As only a fraction of the face-value of the trade is outlaid when trading CFDs a small price change could result in substantial gains but also substantial losses. For example when trading a CFD on a margin of 5%, a price rise of 1% in the underlying market may result in gains of 20%, however, if price fell by 1%, it may result in a loss of 20% of the amount required to open the position.

It is important to remember that leverage is a double-edged sword not only can it work for you but if not managed correctly it can also work against you, often novice trades ignore the fact that if unmanaged leverage can result in substantial losses.

2. Not understanding the impact of trade sizes on your account
Due to the leverage associated with CFD trading, relatively small outlays can result in large moves in your overall account balance.

For example buying 10,000 CFDs priced as $2.40 on a margin of 5% requires an outlay of only $1,200. With an outlay of only $1,200 you can hold a $24,000 CFD position. Should the price of this position move one cent it will have an impact of $100 on the profit or loss on the traders account.

If the price of the this position increased by 12 cents a profit of $1,200 would have been made, However, if the price of the position fell by the same amount a loss of $1,200 would have been made.

The overall impact of any price movement will depend on the traders overall account balance. For a trader with an account balance of $1,500, the aforementioned trade would have had a significant impact on the traders account profit and loss. Should a trader with an account balance of $40,000 open the same position the relative impact would be much less significant.

A loss of $1,200 on a $1,500 account would result in the 80% of the total account balance being lost. However, a loss of $1,200 on a $40,000 account would result in a loss of only 3% of the account balance.

3. Trading in too large parcels
It is important to calculate the exposure your trade size before placing the trade. It is common for novice CFD traders the simply trade the maximum size available to the based on their account balance without considering the amount of market exposure associated with the position.

There are a variety of methods traders can adopt in order to calculate position size. A simply strategy is to determine an acceptable amount of risk capital should the trade go against you and calculate an acceptable position size base on this.

Should you want to restrict losses on any given trade to $200 you would calculate your position size based on your stop-loss price. For example, if the CFD was priced at $1.40 and you stop-loss was at $1.15 your risk amount would be $0.25, to calculate your position size you would simply divide the loss you would be prepared to take by the risk amount. In this case this would be $200 / $0.25 = 800, therefore your position size should be 800 units.

The method outlined above is known as fixed fractional position sizing in which a certain percentage of the overall account balance is risked on each trade. Other methods include allocating a fixed dollar amount to each trade, buying or selling a fixed number of CFDs in each trade or varying the size trades according to the profitability of your account.

Using a position sizing strategy will help you avoid the mistake of placing all of your eggs in one basket.

To find out more about CFD trading you can download our free CFD Guide.