A beginner CFD trader should think about trading in small positions/lots first for a few weeks or months and then gradually go bigger only after gaining enough trading knowledge (through technical and fundamental analysis) and confidence. At the same time, he should remember that online trading is a skill of technical analysis, which improves gradually through daily practice and many mistakes. A trader should be psychologically strong enough so that he can withstand any notional loss and trade with a capital that he can afford to lose, as trading is always risky. Thus a CFD trader should be aware that he is taking a calculated risk.
Risk management is a primary requirement for a trader as per his risk-taking/financial capacity and analysis of the market (price action). Online day or swing trading involves high leverage and thus a trader must apply a suitable stop loss (TSL) along with a target (TGT) to trade in a disciplined way. The TGT/TSL ratio should be a minimum of 1:1 or 2:1. Without proper TSL, the whole margin money may be lost in only one trade. Normally, 10-20% of trades may go wrong over a period, even for a professional trader, and thus application of a proper TSL is essential, treating the same as ‘insurance’ and a quick ‘medication to stop bleeding’ (further loss).
An experienced swing trader generally applies TSL on a breakdown (for a long position) or break up (short position) and often reverses the trade even after the application of TSL to make up the previous loss or wait for the knee jerk movement to fade for entering again. A trader may also exit the trade after TSL and analyze the market/instrument properly before entering again. A professional trader generally analyzes both technicals and fundamentals (underlying news) before entering any trade; if both technicals and fundamentals converge, he may enter into the trade with his normal position, or even double the normal position with confidence, but if it diverges, he should follow technicals with a relatively small position.
Fundamentals tell us where/how to enter a deal (buy/sell) and technicals guide us as to when (price & time). As price & time is the ultimate, a trader could prefer technical analysis because it generally discounts the underlying news in advance. Generally, the financial/capital market is a forward discounting machine and thus technical analysis reflects the trader’s (market participant) mindset, especially in today’s algo age.
Apart from money management, another way to manage risk in online trading is position sizing. A trader can enter/exit a CFD deal in a staggered manner rather than all at once. First, a trader should identify possible supports/resistances for an instrument (for example, Gold) and plan his trade as per underlying and expected news or trend.
For example, a trader plans his Gold CFD trade as:
GOLD: SELL AROUND 1830-1833; TGT: 1810-1790-1750; TSL: 1836
Here, the idea is to enter a sell/short deal around two levels of resistance (1830-33) with 50% at each level; i.e. if a trader plans to sell even one lot in a Gold trade, he could sell 0.50 lot (50%) at 1st level (1820) and watch the price action. If the price goes further higher around 1833 levels, he could enter/sell the rest 50% there and place the TSL at 1836. Now suppose, after some time or news, Gold moves in his favor and falls to 1815 levels, near the 1st support/target 1813-10 zone. Here, the trader could cover at least 25% and modify his TSL above 1815, with a further downside target of 1785-1765. Now if Gold further moves lower to 1800 levels, he could further modify the TSL to 1805 and so on, targeting 1790-1750 levels.
Here the idea is the application of proper TSL even within profit along with position sizing to maximize gain and minimize loss. The original TSL 1836 is essential because sustaining above that Gold may further surge to 1850-53/1880-1905/1915-25 levels. In that scenario, a swing trader may also reverse his trade (after applying TSL) and buy between 1836-1833/30 with a proper TSL for higher targets as above. A trader should always be flexible and may also change his trading view/strategy as per important price action supported by underlying news to avoid any noise or knee-jerk reaction (whipsaw moves).
Another method of risk management is diversification of portfolios in various sectors and stocks rather than investing 100% in one sector/stock. A trader or even an investor should review his portfolio regularly and book profit or average in a staggered manner for maximum gain, minimum risk.
A trader should consider following rules in regular trading to manage risks. Here are some popular strategies traders can follow, however keep in mind that none of the following should be construed as trading advice:
- Plan a proper trading strategy after due diligence; analysis of the technical chart and underlying news flow; if required, take training on basic technical analysis (like HA candle chart, daily Pivot points, some important MA/EMA/HMA, identification of trend line/chart pattern and FIBB ratio)
- TGT/TSL ratio should be a minimum of 1:1 or better 2:1
- TSL should not be more than 1.5-2.5% in any trade; a trader should also calculate the minimum breakeven point after trading cost
- A trader should diversify rather than putting all the eggs in one basket
- A trader should never carry any naked long or short position without being properly hedged
- For a trader, volatility may be a golden opportunity (as well as risk) if he can properly manage his position with a sound trading plan
- A trader should trade in a disciplined way with proper position sizing (staggered entry/exit), and money management