A contract for differences (CFD) is an exciting financial instrument that can help people achieve their trading objectives in a user-friendly means. Note, however, that CFDs still come with risks.
CFD trading, like forex, uses leverage. It means that it can greatly multiply one’s profit or loss. In the trading of CFDs, the greater the risk, the larger the potential profit. That’s why a trader needs to understand that one of the prerequisites for leveraged trading (Forex or CFD) is risk acceptance.
Many CFD trading risks exist, but there are various ways to reduce them. This post will lead you through some tips on how to minimize losses using index CFD risk management strategies. Check them out below.
1. Do Your Homework
Don’t trade with index CFDs before you fully understand the difference between a GBP/USD and a USD/GBP quotes. Don’t start investing before knowing what a market order and what a limit are. It’s essential to understand what you do. Know and understand things both in terms of your particular investment as well as CFD trading basics. Also, choose just a few specializations when it comes to markets and asset classes, and stick with them. Don’t expect to immediately become a specialist in the world of CFD trading.
2. Develop A Trading Strategy
Before opening a trade, make sure to set up a strategy. Figure out how your investment may perform by thinking about potential scenarios. You must know where to close in the worst- and best-case scenarios. What happens if the underlying price goes down by 10%, 20%, or 50%? What if it goes up by 5%?
Choose trading platforms that can help you make informed trading decisions. Pepperstone’s trading platforms, for instance, offer expert commentary and market analysis that you can use to develop your own trading strategy.
3. Utilize Stop Loss Orders (SLOs)
You can add SLOs when you place a trade. If the market is moving against you, a Stop Loss Order helps limit your losses.
When adding SLOs, you’ll choose a specific level where your trade gets automatically closed out. In the event of market gapping, it will automatically be closed out during the next best available price.
If market price gaps, there’s a chance that the closing price will be different from the order level. It means that the closing prices can slightly or significantly differ from the set trigger prices. It’s a risk that you have to remember when placing Stop Loss Orders. Market gapping occurs when there’s a rapid change in prices because of significant market volatility.
4. Order Size
It’s important to calculate order sizes while having enough trading capital available. It’s a way to outlast market movements. As you know, even the best traders don’t achieve profitable trades every time. A good quota of index CFD trades ranges between five to eight profitable trades out of ten.
5. Use Margin Sensibly
You shouldn’t use up all of your account’s free equity as margin. Remember that trade positions must be sized prudently. Always make sure that you got sufficient funds in your account in order to cover any possible losses within the time you decide to hold your trade open.
You could easily find yourself on a margin call if you don’t use margin sensibly. It can happen when your account doesn’t have enough funds to keep open the position. Of course, it comes with a risk of you having it automatically closed out.
6. Limit Leverage
Of course, you can use leverage. However, consider scaling its level down when you have the option. Make it acceptable to risk tolerance profile.
7. Consider External Factors
Don’t forget to consider external factors in your index CFD risk management strategies. The numerous examples of factors that could influence trading quotes include:
- Being busy or getting distracted by office work
- Failing Internet connection and/or power outages
8. Choose A Reliable Index CFD Broker
Another way of making a difference in your trading results is having a good index CFD broker. What are the things to consider when choosing a broker? Of course, the fees are the most important thing. Keep in mind that trading fees can really carve a big portion out from your results. So, make sure that your broker isn’t swallowing all your trading results. Safety is another concern, especially since many scams have surfaced in the financial industry recently.
Whether you’re investing in the Vanguard Balanced Index Fund or trading index CFDs, risk management is an important concept to keep in mind. Plan out the amount of risk that you’re willing to take before you initiate a trade or investment. Your personality, risk tolerance, and financial goals should determine your risk management style. Design a trading strategy with a positive reward VS risk ratio. The main goal is to let your profits run and cut your losses. The tips above can help you achieve that.