Trading markets are unpredictable. One moment, you are making huge profits, and the next thing you know, you might be into a loss too. Though there are ways to understand the trends and statistics that follow over a period, one cannot be a hundred percent sure about the outcome of it. Therefore, when it comes to trading in the capital markets, risk management is essential. Before you venture in and start trading CFDs, formulate a risk management plan for yourself. This will help you in sustaining the market.
The first step is to determine the capital that you are willing to put in. That is the amount that you can willingly lose as well as the profit targets that you are keeping periodically. After understanding these, decide on a risk management plan.
What are CFDs?
CFDs or Contracts for Differences are basically the trading instruments used in the capital market that allow you to trade different products. These products include indices, cryptocurrencies, equity shares, etc. When you decide upon selling or purchasing any CFDs, you hold complete responsibility for the difference that exists between your buying price and the selling price that you receive, without literally owning the trading instrument.
Understanding the concept of risk v/s reward and profit factor
There are two significant ratios involved. The first one is reward v/s risk, and the second one is the profit factor.
- The reward v/s risk ratio is defined as the reward value divided by the risk.
- The profit factor ratio is defined by dividing the gross winning trades by the gross losing trades.
If you are new to the capital market, it is better to dwell on these ratios more seriously and follow them at all times. Decide on a positive ratio so that you don’t have to deal with adverse consequences.
What about risk management?
The risk management plan that you need to come up with must be in compliance with the risk tolerance that you have. That is, you should have a clear idea about how much you are okay with losing and what are the kind of gains that you expect from your trades.
The risk tolerance that you have might vary from another trader’s. Therefore, it is better to integrate one plan for yourself rather than settling for a generic one.
How can you trade CFDs with an effective risk management plan?
- The most basic advice is to indulge yourself in some paper trade before stepping into the market and dealing with real capital. First, test your strategies and see if they can yield some profits.
- The next thing to do is sticking with your strategy. This means that you should not fluctuate and change it mid-way. The key is to be patient and give it time to show results.
- One more crucial thing to keep in mind when it comes to trading CFDs is that you are making use of leverage. Therefore, keep in mind that the higher the leverage, the larger is the risk involved.
Indulge in day trading
Day trading is a common term used in the capital market. It refers to the activity wherein you exit your positions in the market by the end of the day. This happens to be one of the greatest and commonly used risk management plans. The majority of the strategies that are used are based on entering as well as exiting a particular position intra-day.
Therefore, be wise and come up with a risk management plan that involves exiting your position by the end of the trading day. Thus, setting a daily target for you. Or rather, anticipating the daily profit or loss limit that you might have.
Also, keep in mind the slippage as well as commissions that you need to incorporate when trading with CFDs.
Therefore, understand the importance of risk management and how you need to plan it out thoroughly to make the right trading choices with CFDs. Get clarity on the financial conditions as well as the goals that you have and, accordingly, your risk tolerance too. In the CFD trading market, the critical task is to minimize the losses and increase the profits out of it. Therefore, the strategy you plan, and the ratio you decide on should be set accordingly.