How to Manage Risk While Trading CFDs
Trading the financial markets can be daunting, especially if you are a beginner. The prospect of losses while trading can also be scary. When trading CFDs it is important to remember that trading on margin is high risk and although profits can be magnified, so can losses. Therefore, it is important to try and minimise any trading losses that can occur. In this guide, we explore the risks you face when trading CFDs as well as looking at ways that a trader can minimise the risks.
What are the risks when trading CFDs
- Not understanding what it means to trade with leverage
When trading CFDs you will need to place a small initial deposit which represents a percentage of the total value of the position you want to open. If you wanted to open a position worth $500 and the margin rate is 5%, you will need to pay a deposit of $25, but you will still have the same exposure to the position if you had paid the full value of the asset.
However, even though you are exposed to the same position as the full value then if the market moves against you then you could also face losses that exceed the small deposit you initially placed.
- Costs while trading
When trading CFDs, you could incur holding costs depending on the position you have opened and how long you hold them for. These costs could be added to your trading account for specific products you hold past the end of the NY trading session. Having a sufficient amount of funds in your trading account to cover holding costs is an important factor to consider.
- Account close-out
If you don’t have sufficient funds in your account to cover your total margin requirements, your positions could close out if the balance went below the close-out level. Make sure you keep an eye on your trading account to avoid this. There are reasons why the balance in your trading account can close quickly including market volatility which leads to changes in prices that could take place outside of market hours.
Now that we have looked at some of the risks you can incur when trading CFDs, there are also ways in which you can minimise CFD trading risk which we will explore below.
How to minimise CFD trading risk
- Make sure you stick to the trading plan you have in place
Before you enter the financial markets, you should have a trading plan in place. This plan should establish your goals and objectives before you open positions, that way you can monitor your progress and it also ensures that you stick to your financial goals. Here is our guide on how to create a successful trading plan.
- Understand the asset you want to trade
Make sure you understand the market you want to trade as well as the different factors that can cause the assets price to move. This will help you to have a trading strategy in place before opening the position.
- Set up stops and Limits
Setting up stop loss and profit levels can minimise CFD trading risk. With prices fluctuating in markets quite frequently, you might not be expecting the market to suddenly move against you. Having a stop loss in place will protect you against the sudden market movements you might encounter. Read more about risk management tools here.
Trading on margin is high risk.