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Managing Risk
Managing risk when trading is a crucial to achieving success in the financial markets. Successful traders typically use a risk management plan to minimize the potential for losses and maximize the potential for consistent gains. CFD trading and spread betting allows traders to speculate on the price movements of financial assets without owning the underlying asset. While this kind of trading offers many advantages, such as the ability profit from both rising and falling markets, it also comes with heightened risks due to leverage. We cover several risk management techniques below for traders to use.
Set Risk Tolerance Limits
The first step in managing trading risk is to define your risk tolerance. This is the amount of money that you are willing to risk on any given trade. A trader's risk tolerance should be based on their overall financial situation and their investment goals. It is important to consider setting clear risk tolerance limits before entering trades. This will help you avoid making emotional decisions when market conditions are unfavourable. Leveraged trading is high-risk and so traders should be aware of the risks involved and only trade with money they can afford to lose.
Set Stop Loss Orders
Stop loss orders are an essential tool for managing risk in trading. A stop loss order is an instruction to close a position at the first available price at or beyond your chosen price level. If the market moves against you whilst you’re not at your screen, a stop loss can be a useful tool to limit losses.
Do note that a standard stop loss does not guarantee that you will be closed at your stop level. Let’s say you’re long a stock that trades at 120p, you have a stop at 100p and, after some negative news, the stock opens the next day at 90p. 90p is the first available price below your stop and so this is where you’re filled. If you want to guarantee that your trade is closed at your stop level (100p), you can use a guaranteed stop.
Use Proper Position Sizing
Position sizing in spread betting involves determining the amount of capital to risk on a trade, considering factors like volatility, spread size, and desired risk tolerance. This can be calculated based on the distance from entry to stop-loss and it helps manage potential losses and aligns with risk
Diversify Your Trades
Diversification is a strategy used to spread risk across multiple trades. It may help to consider two types of risk. The first is idiosyncratic risk which refers to factors that can negatively impact an individual security or a very specific group of securities. Think Tesla earnings for example. The second is systematic risk which refers to the risk inherent to the entire market. Think a recession for example. Diversification helps reduce idiosyncratic risk. Sure, it wouldn’t be great if you own Tesla in a portfolio of 10 names and it has bad news out, but it would be a lot worse in a portfolio of just Tesla! For maximum diversification, it’s advisable to hold multiple trades that are not connected to each other – i.e., different sectors, asset classes, etc.
Monitor Market Conditions
Monitoring market conditions is essential for managing risk in CFD trading and spread betting. You may like to stay informed about the latest news and developments in the markets you are trading. This will help you identify potential risks and adjust your trading strategies accordingly. On the Spreadex platform there are various tools traders can use such as the economic diary, price alerts, watch lists and daily market updates.
Control Leverage
Leverage is a key feature of spread betting that allows you to control large positions with a relatively small amount of capital. However, leverage also increases the potential for significant losses. You must exercise caution when using leverage and ensure that they do not overleverage their positions. You can do this by leaving excess funds on the account which will act as buffer in case the price goes against you in the short term
In conclusion, managing risk requires you to understand the risks involved, set stop loss orders, use proper position sizing, diversify their trades, monitor market conditions, and control leverage. By following these strategies, you can minimize the potential for losses and increase their chances of long-term success in trading.
OPTIONS TRADING
Dive into the world of options trading with our comprehensive educational guide. Understand the basics of call and put options, explore key components, and learn how factors like implied volatility and time decay influence option premiums.
