How to calculate your risk in CFD trading

How to calculate your risk in CFD trading

When you’re rushing out the front door in the morning, it may seem like a waste of time to go back to fetch your raincoat, but you’ll think differently when it starts pouring while you’re waiting at the bus stop. Investing in the financial markets via CFD trading is similar: although the outlook may be sunny, there is always the risk of rain, since all forms of online investing come with risk. The key is to incorporate various measures of risk management into your everyday trading strategy which can help you not only help minimize your potential losses, but make you a more aware trader overall. Even experienced traders, hit with a series of losses in the absence of proper risk management, can find themselves forced to stop trading for lack of funds. This is why it’s common sense to put a few simple strategies in place before you start investing in CFDs.

Setting Limits

Just taking this point seriously can make a lot of difference. No matter how convinced you are about the position you are about to take, don’t put more funds than you’re able to on the line. How much is too much? That all depends on your financial means. There’s no right answer for how much money you should risk, but it does help to do your research and see what other trading specialists in the arena say. It would be foolish to put yourself in a situation where some market volatility on a certain day knocks you out of the trading arena in one go. And, if you are opening many positions, work out how much you would lose if everything went against you, and ensure you’d still be stable – emotionally and financially. A suggestion would be to make the rooftop for total losses from all positions about 10% of your account balance, but again—this is not set in stone and should not be taken as sound trading advice. Needless to say, your limit-setting should take into account the reality of your financial situation. Never decide to throw caution to the wind and put down your savings on a single deal.

Stop-Loss Orders

When you’ve put your money on the line on a “buy” deal and are watching stock prices anxiously to see if they’re going to rise, you may not react reasonably if things don’t go your away. In particular, beware of the temptation to keep your position open even though prices are going against you, in the hope things may change. Don’t leave it to yourself to decide when to cut your losses. In fact, you are disqualified as a judge on the matter. Rather, set a stop-loss order before opening the deal at a pre-decided level below the current market price, so your position will be automatically closed before your losses compound. On the other side of the coin, traders can be tempted to leave their earnings unclaimed in the hopes they will mushroom. Set a take-profit order at a level that you assess would constitute a success for this trade, so your potential earnings will be automatically credited to your account.

Correct Diversification

It wouldn’t be wise to put all your funds in one industry – say, the crypto industry. What if some kind of legislation were to hit this industry and take a big chunk out of it? Aside from that, consider the effects geopolitical circumstances could have on your instrument or sector. Are they going to make traders more risk-averse and therefore more likely to head toward safe haven investments? You don’t want to put all your funds at the mercy of a single change in market sentiment. Rather, it's generally a good idea to diversify your portfolio across various sectors. This does not mean you should scatter your money across as many assets as possible. Instead, do proper research on each industry or company you’ll be investing in through CFD trading and apportion your funds deliberately.

Negative Balance Protection

CFD trading with the use of leverage puts you at risk of going into a negative balance. If you put down $500 to open a “buy” deal on Bitcoin with leverage of 20:1, your deal will be worth $10,000. Obviously, this puts you in the position to increase your earnings much more than a $500 deal could offer you. On the other hand, if Bitcoin has a bad day and loses 12% of its value, your loss will be 12% of $10,000, which is $1,200. Now, you’ll owe your broker $700 more than your original deposit. Offered as a standard feature by regulated brokers, negative balance protection saves you from owing your broker money beyond what’s in your account. Still, that doesn’t mean you should ever open deals with abandon. Always practice prudence when investing in CFDs.

Wrapping Up

As time goes on and your life circumstances change, your risk management strategy should evolve too. Just remember that investing in CFDs is not a race or a competition. There should never be a hurry to become good or make money. Take your time learning the ins and outs of risk and trade CFDs in a way that’s kind to you and your level of experience.