Like all financial products there are risks in buying and selling CFDs. Risk is usually related to profits, the riskier the investment the higher the possible returns, however if risk is managed correctly it can be considerably reduced. When buying and selling CFDs this can be done with the utilization of stop-loss orders and simple portfolio hedging. This short article explains the primary risks linked to trading CFDs and what can be done to decrease them without having a bearing on the significant returns that CFDs can provide.
Prior to trading CFDs you must recognize that CFDs are a leveraged product which enable them to work for you as well as against you. Like all leveraged products a small price movement can deliver substantial returns and also significant losses. The variety of order types offered to CFD traders allow the risks connected to adverse price changes to be considerably reduced as CFD traders are able to set their order at a price which they are prepared to close out their position and realize a loss. Common order varieties utilized to alleviate risk are stop-loss orders, trailing stop-loss orders and guaranteed stop-loss orders.
Stop-loss orders
This is the most common order type employed by traders to control risk. A stop-loss order is simply an order to shut an existing open position that is positioned at a price below or above the present market price. The order is placed at a price that the CFD trader is prepared to shut out their open position. It is essential to note stop-loss orders tend to be susceptible to slippage should the price of the CFD gap, this is a regular occurrence when trading share CFDs.
Trailing Stop-loss orders
Trailing stop-loss orders are similar to stop-loss orders with the exception that the price of the order moves in accordance with a pre-determined distance from the present trading price, this distance is set by the trader at the time of placing the order. It is important to note that the price of the order will only alter if the price of the instrument moves in a favorable direction, should the price move against the trader the price of the trailing stop-loss order won’t change. This order type works like a ratchet, in that it can be used to lock in gains as the position moves in favor of the CFD trader without the need for the trader to continually change the price of the stop-loss order.
Guaranteed Stop-Loss orders
Guaranteed stop-loss orders have become commonplace in recent times because of traders being able to predetermine their losses. This order type is generally used when trading share CFDs purely for the reason that share CFDs are prone to slippage and gapping during the opening phase of the market. It’s vital to note that when using guaranteed stop-loss orders your CFD provider will often charge you a premium, this is like an insurance premium guaranteeing that you’re going to be filled at the price your stop-loss order is placed.
Besides using orders to deal with your risk when trading CFDs many traders use other financial products such as shares and options to hedge their CFD positions.
Shares are normally used to hedge CFD positions or vice versa, these are regularly employed by traders that hold a portfolio of stocks and also a short term CFD trading account. CFDs are used to trade the short term price movement of the stocks within their portfolio without needing to sell the stocks and realize any capital gains.
Options are used by a number of CFD traders as a type of guaranteed stop-loss. Options have a bonus over guaranteed stop-loss orders in that they are often cheaper. Hedging CFD positions using options is a common strategy employed by more advanced traders that are familiar with the core components of an options contract and are familiar with how to choose the most suitable contract to hedge their CFD position with.
Other than managing risk using order types and hedging strategies all CFD traders should make certain that they adopt strict money management techniques, meaning that they should not utilize too much leverage or over expose themselves to one individual CFD or sector. Utilizing too much leverage is the single most frequent mistake made by novice CFD traders.
Prior to opening a real CFD account you ought to ensure that you practice trading on a demo account to so that you are familiar with how to make use of the many order types available which will help you deal with risk. Keep in mind CFD trading can be tremendously satisfying if the risks are controlled.
Hassam 