Traders are temporarily the owners of the assets or instruments they trade. Because they cannot speculate on the price changes without buying it for a price first. This was the case of traditional trading where assets were bought and sold to make a profit from favourable fluctuations in prices. But CFD trading truly changed the way financial markets were approached.
You won’t be at a loss even if the market is bearish and this was nothing less than a revolution in the world of trading. You never become the owner of any CFD you trade as it is not an asset but an asset-based contract for difference.
You get a chance to make profits by following the price but you won’t be buying or selling anything for a price. You can bid bye to the ownership risk and earn profits by being akin to the market movements. But you are not fully safe as the market risk is still there and this blog will get into the details so you can manage it better and succeed in CFD trading.
The Essence of CFD Trading
I know that we are always into the rewards that can be unlocked as a trader but it will not be possible unless you are aware of the risks involved. To fully understand the risk, you have to dive deeper and get a grasp of the market dynamics. Here, you need to start by learning the very essence of CFD trading. You can think of CFDs as a derivative but it is not like futures and options. While trading CFDs, you are simply taking a position to profit from the appreciation or fall in an asset’s value.
Talking about the underlying assets, it can be currency pairs in the forex market or shares in the stock market. You can even choose commodities and indices or even cryptocurrencies. So, you get to explore multiple markets and instruments without limiting yourself to one market only. Whether the prices fall or rise, trading opportunities will be there.
You just have to take a position depending on the direction in which you expect the market to move based on your analysis. If your analysis says that the market will go up, you can go long as well (buy position) and if you think the price is going to drop, you should open a short position instead.
Market direction is not the only thing to consider for winning in CFD trading. You will have to find optimal price points for opening and closing trade positions. Most CFD brokers provide tools like pip calculators as tracking the pip change is important to assess the risk. Even the stop loss level is decided after counting the pips from the entry point and converting to your account base currency, for estimating the risk. Let’s see what more can be done to minimise the risk and preserve your trading capital.
Strategies To Safeguard Your Capital In CFD Trading
Risk management is not just about locking your profits but it starts from safeguarding your capital. Those who don’t pay much attention to risk management in trading end up losing all their money in the CFD market.
The first step that you have to take for a secure trading experience is selecting a reliable CFD broker. Check if the broker is regulated and consider the trading conditions, technology, and trading platforms being offered.
There are a lot of old and new trading platforms that are ideal for exploring the CFD market. The classic MT4 platform does support CFD trading but MT5 wil be a better option for multi-asset trading. Once you finalise the broker and trading platform, you can start off your trading journey by following a strategic approach to deal with the risks.
- Test Your Strategy On A Demo Account
Spare a few minutes to sign up for a demo account and save yourself from making costly mistakes. In demo accounts, you can freely learn without having to beat yourself up for the losses. Because you will be trading with fake funds and the account is just a replica of a real trading account. You get experience trading in a realistic way and test your strategies but the profits or losses won’t become real. Consider it as a practice session and a place to sharpen your skills as a CFD trader.
- Learn About Leverage And Margin
Learning about leverage and margin is a must in CFD trading. Leverage is like an accelerator that makes your account grow faster. It amplifies the trade size allowing you to attract bigger gains even if you can only trade with a small amount of capital. But the risk of a bigger account drawdown and margin call is there when you lose the leveraged trades. Thus, you have to be very careful with leverage.
- Diversification & Hedging
When your risk is spread across different markets and assets, the result of a single trade will not make a huge difference to your account balance. This is the theory that is applied in diversification. So, choose different types of CFD instruments to mitigate the risk and also try hedging to offset the risk of one position with another.
- Placing Stop-Loss & Take-Profit Orders
A stop-loss order saves you from losing more than what you can afford and a take-profit order preserves the profit that you earned by winning a trade. The exit will be automated in both best and worst-case scenarios. While setting the take-profit level, you can use a profit calculator to estimate the projected gains in advance.
- Set & Stick To Your Risk/Reward Ratio
If your risk/reward ratio is 1:2, you should never open a trade that has higher risk and smaller rewards in comparison. This will be a losing game in CFD trading as you are not making much profit to compensate for the risk that you are exposed to. So, make sure that the risk is under control and maximise the potential earnings.
- Emotional Control
The decisions we make often get influenced by our emotions and this will never end well for a trader. You have to control what you are feeling instead of letting it consume you and your intellect. You must think rationally and conclude only after considering the consequences. You should never enter a trade just because you feel that it will work out in your favour. You have to prioritise logic and follow a professional approach.
- Regular Review & Revision
To assess the viability of your strategy, you have to review your trading history and trading journal regularly. If your account performance is not up to the standard that you have set for yourself, you have to revise the strategy. Moreover, you should continue learning and refining your skills for better results.
- Setting Daily Limits
Overtrading can ruin your trading career and even push you to huge financial losses. This can even turn into an addiction which leads to physical and mental exhaustion. Hence, you have to trade responsibly and set daily limits on your trading hours, the number of trades that you can enter and the maximum loss you can take for a day. You have to stop trading once the threshold is reached.
- Understand Market Conditions
The success of CFD trading depends on your ability to understand and adapt to the changes in market conditions. Technical analysis alone may not reveal the entire picture of where the market is headed. Hence, you should also combine fundamental analysis by keeping an eye on the news and using tools like economic calendars.
So, these are some simple yet powerful strategies to manage your risk as a CFD trader. By being focused and disciplined, you can easily deal with the risk and realise your goals.
